What’s the Difference Between Subsidized and Unsubsidized Loans?

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Most students need to use federal student loans or private student loans to fund their college educations. When you take out federal student loans to pay for school, the loans are either Direct Subsidized Loans or Direct Unsubsidized Loans. Direct Subsidized Loans are federal student loans available to undergrads that do not accrue interest while the student is in school or when loans are deferred after graduation.

The government sets the interest rate on Direct Subsidized Loans, there is no minimum credit score required to qualify, and rates are fixed. However, the amount students can borrow is limited. Students must complete the Free Application for Student Aid (FAFSA) to become eligible for Direct Subsidized Loans, and eligibility is based on demonstrated financial need.

Direct Unsubsidized Loans are also federal loans, and students must complete the FAFSA to be eligible. However, eligibility for Direct Unsubsidized Loans isn’t based on financial need, and students are responsible for interest on Direct Unsubsidized Loans, even while you’re in school or while your loans are in deferment after graduation. If you don’t make interest payments, the unpaid interest is added to your loan balance, making repayment more costly.

Understanding the difference between subsidized loans and unsubsidized loans is essential because it can change how your student loan interest works, the amount you pay, and how you decide to tackle student loan repayment.

Subsidized vs. unsubsidized student loans: Understanding the difference

Subsidized and unsubsidized loans are both available through the federal government for student borrowers. However, there are some important differences between them that you’ll need to understand if you are borrowing for school. Here’s what you need to know about each of these different types of student loans.

What is a Direct Subsidized Loan?

“Direct Subsidized Loans are federal loans where the federal government will pay the interest while the student is in school,” explained Fred Amrein, founder and owner of Amrein Financial. The government pays interest on a subsidized loan while you’re enrolled in school at least half-time. If you’ve already graduated and put your loans into deferment or forbearance, the government also covers interest on your subsidized loans.

While students are not required to pay interest on a Direct Loan while in school, interest begins to accrue immediately. “Either someone needs to pay that interest, or that interest is added to the original (principal) amount of the loan,” said Peter Bielagus, a financial author and speaker.

If a student takes a $10,000 Direct Subsidized Loan as a freshman, four years later, the loan balance will still be $10,000 because the government pays your interest costs. “The amount of the loan did not grow because the government made the payments for you,” according to Bielagus.

Direct Subsidized Loans are designed for lower-income, undergraduate borrowers. According to the Department of Education, your school determines the amount of Direct Subsidized Loans you’re eligible for and the amount borrowed via a subsidized loan cannot exceed financial need.

Pros of Direct Subsidized Loans

  • The U.S. government pays the interest on your loan as long as you remain enrolled at half-time status.
  • Interest is paid by the government on eligible loans during deferment and forbearance, as well as on certain repayment plans. Find out more about how this works with this helpful guide to federal loan interest subsidies.
  • No payments are due until after the first six months of graduation.

“The biggest difference is that a subsidized loan does not get bigger, but an unsubsidized loan can,” said Bielagus.

Cons of Direct Subsidized Loans

  • Graduate students don’t qualify for subsidized federal student loans.
  • Students who can’t demonstrate financial need — which can happen if parents earn too much — cannot qualify for this type of financial aid.
  • Annual loan limits are lower for Direct Subsidized Loans than for Direct Unsubsidized Loans. The total aggregate loan amounts are capped at $23,000 for subsidized loans.

What are Direct Unsubsidized Loans?

Direct Unsubsidized Loans do not offer additional financial assistance. Even though they’re still offered by the federal government, Uncle Sam won’t pay the interest on unsubsidized student loans.

“With an unsubsidized loan, the student is responsible for making the interest payments the moment the loan is taken out,” said Bielagus. “If the student does not make the interest payments, then those payments are simply added onto the principal amount.” As he explained, this could mean a $10,000 loan taken in freshman year might grow to $13,000 by graduation, thanks to interest accruing and being tacked onto the principal.

The government does not pay interest on Direct Unsubsidized Loans because these are general loans not based on financial need. Borrowers must repay their debt in full, interest and all.

Pros of Direct Unsubsidized Loans

  • Both undergrad and grad students can apply for Direct Unsubsidized Loans.
  • Potential borrowers don’t need to prove financial hardship to qualify.
  • Annual loan limits are higher than for a subsidized loan, with a total aggregate loan limits cap of $31,000.

Cons of Direct Unsubsidized Loans

  • Borrowers are responsible for paying all the interest on their unsubsidized loans, even during the grace period after graduation and during deferment or forbearance.

Similarities between Direct Subsidized Loans and Direct Unsubsidized Loans

Though there’s a big difference between subsidized and unsubsidized loans, both of these types of federal loan options share several similarities including:

  • Amount borrowed: Your school determines the amount you’re able to borrow. After you submit your documents, the school offers you a financial aid package detailing how much you can take in subsidized and unsubsidized student loans.
  • Length of financial aid: For both of these types of Federal Direct Loans, the longest eligibility period is 150 percent of the length of the college program you’re enrolled in. For instance, if you attend a full, four-year undergraduate program, you’ll qualify to receive six years worth of loans.
  • Interest rates: The current APR for undergraduate subsidized and unsubsidized loans is 4.45% (between July 2017 and July 2018), according to the U.S. Department of Education. The unsubsidized graduate degree loan interest rate is 6.00%.
  • Loan fees: Both loans have the same fee. For subsidized and unsubsidized federal student loans, the fee —which is charged to the aggregate total — is 1.069% for loans disbursed after Oct. 1, 2016, and before Oct. 1, 2017. The fee is 1.066% for loans disbursed on or after Oct. 1, 2017, and before Oct. 1, 2018.

When you compare subsidized versus unsubsidized student loans, you do not need to worry about these important criteria differing from loan to loan.

Should you prioritize paying a subsidized loan or an unsubsidized loan?

When prioritizing loan repayments, it’s a good idea to repay your Direct Unsubsidized Loans first before paying back your Direct Subsidized Loans. Because an unsubsidized loan continues accruing interest while in school, the balance of your unsubsidized loans will be larger unless you paid the interest while in school.

As our student loan deferment calculator shows, a $30,000 loan at 4.45% interest would accrue $1,335 in interest over one year while your loan was in deferment. If the loan was an unsubsidized loan from senior year and you didn’t pay interest during the year, your balance would be $31,335 at graduation. You’d have to pay interest on $31,335 while your Direct Subsidized Loan would still be at $30,000 so you’d pay interest on a lower amount.

Not only could you save on interest by paying the loan with the higher balance first, but repaying your Direct Unsubsidized Loans first means that if you go back to school or otherwise qualify for deferment or forbearance, you won’t have as much unsubsidized debt for interest to accrue on.

Direct Subsidized Loans vs. Direct Unsubsidized Loans

It makes a big difference whether your interest starts accruing while you’re in school or you get a pass until you graduate. Keep this in mind when you choose your student loan repayment strategy and work toward becoming debt-free after college.

In most cases, it might make sense to choose Direct Subsidized Loans if you qualify. After all, with the government paying your interest while you’re in school, you can save quite a bit of money.

If you’re still not sure which repayment option is best for you, answer a few questions below and we’ll help you find a solution!

Miranda Marquit and Paul Sisolak contributed to this article.

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