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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    What are subsidized and unsubsidized student loans?

    While students can apply for finance through private lenders, millions will instead take out loans from the U.S. Department of Education. Many of these students will take out finance in the form of a Federal Direct Loan.

    Federal Direct Loans are low-interest student loans for both undergraduates and graduate students. These loans come in two types: subsidized and unsubsidized loans.

    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 prosNot based on financial need
    Fixed interest rates
    Unsubsidized loan consPotential 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 prosDept. of Education covers interest while in school
    Fixed interest rates
    Subsidized loan consLower 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.

    Who qualifies for these types of student loans?

    Both subsidized and unsubsidized student loans have a few requirements you need to meet to be eligible. In both cases, the student must:

    • Be a U.S. citizen or an eligible non-citizen
    • Have a valid Social Security number
    • Be enrolled at least half-time in a school
    • Have satisfactory academic progress
    • Have a high school diploma or equivalent
    • Not be in default on existing federal loans
    • Be registered with the Selective Service System (if applicable).

    There are also some eligibility differences between subsidized and unsubsidized student loans. Subsidized loans are only for undergraduates with a demonstrable financial need. On the other hand, unsubsidized loans are available to any student who applies for them as there is no financial need requirement.

    How much can you borrow?

    In the case of first-year undergraduate students, you can borrow a combined $5,500 if you are still financially dependent on your parents. However, only $3,500 of that amount can be from a subsidized loan.

    Those who don’t rely on their parents can borrow up to $9,500 for their first year, but only $3,500 can be from subsidized loans.

    For the following years, the borrowing limit increases. The total overall borrowing limit is $23,000 for those dependent on their parents with, the option to borrow a further $8,000 in unsubsidized loans. For independent students, this total limit is $57,500 but only $23,000 of that can be from subsidized loans.

    Subsidized vs unsubsidized: How to choose

    Choosing whether to go for subsidized or unsubsidized loans will depend on your financial situation. However, if you are eligible for subsidized loans, it could be well worth applying for them to save on the interest costs at first.

    • How much do you need to borrow? When weighing what type of loan to choose, it’s important to consider how much you need. There is a limit on how much you can borrow in subsidized loans. With unsubsidized loans, you can borrow more, which is why many people choose a combination of the two.
    • Undergraduate vs. graduate. Whether you’re an undergraduate or a graduate student will also factor into your eligibility for either loan type. As of 2012, graduates can only receive unsubsidized loans and are not eligible for subsidized loans. However, undergraduates still have the option of either type of loan. Therefore, if you are an eligible undergraduate, it may be a no-brainer to choose a subsidized loan.

    Repayment options

    Typically, once you are due to start repaying your loans, you will be automatically enrolled in the Standard Repayment Plan. This plan has a term of up to 10 years and consists of equal repayments each month.

    With the Graduate Repayment Plan, repayments start lower and are increased in increments. While this plan has a term of up to 10 years, you will be paying more than you would with the standard plan.

    An alternative method is the Income-based Repayment plan (IBR). This sets your repayments to be around 10% to 15% of your monthly income which can be spread out across 20 to 25 years. This can be a much more manageable option month-to-month, but you’ll pay considerably more interest over that longer time.

    Federal loan FAQs

    The benefit of subsidized loans vs unsubsidized loans is that the government pays your interest for you to begin with. However, you can borrow more money with an unsubsidized loan. Which loan is better depends on your needs.

    You will need to repay any type of loan you take out, but you can start repaying your unsubsidized loan interest while you are still at school.

    If you have an unsubsidized loan, you should try to pay off your accrued interest before the loan repayments kick in. Any unpaid interest gets added to your total loan amount once you leave school. Therefore, if you have both types of loans, you should aim to start paying the interest on your unsubsidized loan first.

    Subsidized loans are loans supplied by the federal government, based on financial need. The Department of Education pays the interest on these loans while you’re still at school.

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    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 who leads our news and opinion coverage. She specializes in financial policy, banking, and investing.