Subsidized vs. Unsubsidized Loans

Many students use loans to fund their higher education goals. Some opt for private student loans, while others take advantage of the federal loans available.

The federal government offers fixed interest student loans to college students through both a subsidized loan and unsubsidized loan program administered by the U.S. Department of Education. Of the two types, the subsidized loan is the best option for low-income students because interest payments are covered while students are in school. This keeps the loan from ballooning with interest when deferring payments.

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It’s important to note the difference between private loans and federal loans, as explained by Colleen Brown, director of financial aid at Columbia College.

“Private loans are typically credit-based and often have an interest rate associated with the creditworthiness,” says Brown. “Federal loans also have other ‘benefits’ that private loans don’t have. For example, federal loans do have death and disability discharge where [with] private loans, it varies by loan product.”

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    Unsubsidized loans vs. subsidized loans

    The college or university helps set the amount of both the Direct subsidized and unsubsidized loans offered to a student. The school examines the amount of money it will cost to attend as well the other financial aid received, including grants. While the student is enrolled in school at least half-time, both loan types can be deferred, meaning the student does not have to pay interest. This offer also extends as a “grace period” for the first six months after leaving school.

    “A subsidized loan is one that the government pays interest (on) while a student is in school as well as during deferment,” Brown explains. “An unsubsidized loan is one that the student is responsible for the interest during the entire time the student has the loan. Both are types of federal Direct loans. They are both federally guaranteed and do not require a credit check or collateral. A student who is eligible for subsidized loans should utilize subsidized before unsubsidized due to the expense of capitalized interest.”

    As of December 2019, the maximum loan total for first-year independent students was $9,500 with $3,500 of subsidized loans. In the second year, the limit climbs to $10,500 and $4,500, respectively. For subsequent years, the maximum is $12,500 per year total and $5,500 in subsidized loans. Graduate students are only eligible for a maximum of $20,500 in unsubsidized loans.

    Unsubsidized loans

    Unsubsidized loans are not offered based on financial need. This means that a student can qualify even if they have a job or are a dependent of parents whose earnings disqualify then from receiving other aid, such as federal grants or subsidized loans. To qualify, you must be enrolled in a degree or certificate program, and you must stay enrolled as at least a half-time student. For a normal course load of 30 credit hours per year, taking 15 credit hours of classes would be half-time enrollment.

    In school, interest starts to add to the first loan the day it is disbursed. Loans taken in subsequent years start accruing interest as they are taken. When you are enrolled at least half-time, you can elect not to make principal or interest payments.

    The fixed interest rate for loans disbursed before July 1, 2020 is 4.53% for both subsidized and unsubsidized undergraduate loans. Graduate loans featured a 6.08% interest rate while PLUS loans, or loans provided to parents, have a 7.08% rate. Over a four-year period, accumulated interest can add a large sum to the loan amount.

    According to the Office of Federal Student Aid, a $10,000 Direct Unsubsidized Loan with a 6.8% rate accrues $1.86 in interest per day. For current students, interest is added to the balance, or capitalized, after deferment, forbearance or grace period ends. When the interest is capitalized, new interest charges start accumulating on the old interest. To avoid this, make interest payments while in school or hustle to pay off the interest during the six-month grace period post-graduation.

    Unsubsidized loan prosUnsubsidized loan cons
    • Not based on financial need.
    • Fixed interest rates.
    • Potential for capitalized interest.
    • Must be enrolled at least half time.

    Subsidized loans

    Subsidized loans are offered based on financial need using the information provided on the Free Application for Federal Student Aid, or FAFSA. Direct loans and federal grants may be part of the financial aid package offered by the school.

    Before accepting any unsubsidized loans, make sure you have maxed out your subsidized loans. Why? The interest on subsidized loans is picked up by the U.S. Department of Education until the post-graduation grace period ends. Because the interest is paid, it never capitalizes, and the balance of the loan, when it’s time to pay it off, is for the original amount of money borrowed.

    Subsidized loans are at your disposal for up to 150% of the amount of time it should take to complete your degree program. For example, you can only receive subsidized loans for 6 years on a 4-year degree. Even if you switch programs, your past loans still count toward your new total.

    Subsidized loan prosSubsidized loan cons
    • Department of Education covers interest while in school.
    • Fixed interest.
    • Lower loan limits.
    • Not available on graduate loans.

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    How to apply for federal loans

    To apply for federal student loans and grants, you need to fill out a FAFSA form for every school year. The FAFSA requires information about household finances, so a recent tax return may be required. Also gather your Social Security number, recent bank statements and any investment records. If you are applying for aid as a dependent of your parents, sit down with a parent or legal guardian to fill out the FAFSA together because you will also need all of their financial records. You must also obtain a Federal Student Aid ID through the U.S. Department of Education website. This ID will stick with you through each year of applying for aid and repayment of loans.

    When you fill out the FAFSA, you provide information about your school or potential schools, and each school receives the FAFSA data and extends financial aid offers — just like your schools received your ACT and SAT scores. You do not have to accept all loan opportunities that are offered to you. For example, if you receive federal grants and scholarships to cover many of your expenses and can meet the remainder of your costs with a subsidized loan, you can decline any unsubsidized loans that are offered. When you accept a loan for the first time, you must complete an entrance counseling program. All loans also require signing a Master Promissory Note, aka loan agreement.

    Ashley Mott

    Contributor for The Simple Dollar

    Ashley Mott is a full-time journalist with over 10 years of experience in small business management. Her work has been featured in USA Today and at, The Knot, Yahoo! Finance and the San Francisco Chronicle.

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    • Andrea Perez
      Andrea Perez
      Personal Finance Editor

      Andrea Perez is an editor at The Simple Dollar specializing in personal finance. Prior to that she specialized in digital marketing content for online learning websites. She holds a master’s degree in journalism and media studies from the University of South Florida.