Diff between subsidized and unsubsidized student loans

Financial Aid

The differences between Subsidized and Unsubsidized Loans include the timing of when interest starts accruing, the eligibility for awarding based on financial need, and the maximum amount permitted.

In the financial aid packages you received recently, you likely noticed one or two federal student loans. The Federal Direct Student Loan, commonly referred to as the Stafford Loan (its former name) or the William D. Ford Loan (its official name), is awarded to almost every student who submits a FAFSA. It's a loan funded by the federal government, and is included as a part of financial aid because of its low, fixed interest rate and favorable repayment options. The Direct Loan comes in two formats: Subsidized and Unsubsidized. What's the difference between the two? Read on.

What are Subsidized Loans?

• Both Subsidized and Unsubsidized Loans accrue interest while you're in school, but the U.S. Department of Education will pay the interest on your Subsidized Loan until six months after you graduate or until you drop below half-time enrollment. That means the Subsidized Loan will ultimately cost you less over time than your Unsubsidized Loan.
• Subsidized Loans are awarded based on financial need. Schools start with their Cost of Attendance (the total cost for one year at that school) and subtract your Expected Family Contribution (the amount your family can pay for one year of school) to determine your financial need. They then do their best to fill in this need with need-based financial aid, including the Federal Direct Subsidized Loan.
• You can receive, at max, $3,500 in a Subsidized Loan for freshman year. And the combination of your Subsidized and Unsubsidized Loans cannot exceed $5,500. 

What are Unsubsidized Loans?

• You don't have to demonstrate any financial need to receive an Unsubsidized Loan.
• You can receive, at max, $5,500 in an Unsubsidized Loan for freshman year. And the combination of your Subsidized and Unsubsidized Loans cannot exceed $5,500.
• Though your Unsubsidized Loan will accrue interest while you're in school, you don't need to pay that interest until six months after you graduate or until you drop below half-time enrollment.

What Do Subsidized and Unsubsidized Loans Have in Common?

• Both have the same fixed interest rate. That rate for the upcoming academic year's loans is determined at the end of May every year, and is set for the life of the loans. You can view the current interest rate here.
• Both have an origination fee, which will be subtracted from the loan amount before the loan funds are placed in your student account. You can view the current origination fee here.
• You'll need to complete entrance counseling and sign a Master Promissory Note before receiving your loans. Your college will provide instructions on how to complete these requirements.
• You'll have several options on how to repay your loans once repayment begins.

You'll need to submit your FAFSA every year to receive your Federal Direct Student Loans, so make sure that's on your radar. And know that you don't need to borrow the full amount of student loans that you receive. You can request that your financial aid office reduce your loan amount anytime.

Learn more about federal student loans

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Nearly a third of all college students take out student loans in their own name, according to Sallie Mae, a leading education lender. If you’re one of them, federal loans are by far the best choice.

But even among federal loans, some options are better than others. The federal government offers two types of Direct Loans: Direct Subsidized and Direct Unsubsidized Loans. Undergraduate students can take out federal Direct Loans at a standardized interest rate, with no credit checks, cosigner, or minimum income requirements. 

Direct Subsidized Loans have a lower cost of borrowing since the government pays the interest while the borrower is in school. But there’s a catch — not everyone can qualify for them. Students may be eligible for only one type or a combination of both depending on the information they submit in the Free Application for Federal Student Aid (FAFSA).

Pro Tip

Some financial aid is issued on a first-come, first-served basis, so fill out the FAFSA as early as possible to maximize your chances of receiving aid. 

Even if you can’t qualify for a Direct Subsidized Loan, federal loans should still be your first choice when it comes to borrowing money for college. Federal loans offer income-driven repayment plans, the potential for loan forgiveness under certain circumstances, options for forbearance and deferment due to financial hardship, and an overall stronger safety net that no private option can match. 

Let’s talk about the two types of federal Direct Loans, how to find out which ones you qualify for, and how to decide which loan is best for you. 

Main Differences Between Subsidized and Unsubsidized Loans

Federal Direct Subsidized and Direct Unsubsidized Loans are the two options available to undergraduate student borrowers. Direct Subsidized and Unsubsidized Loans don’t require credit checks or have minimum income requirements, making them useful options for students that may not have much income or credit history yet. These loans are taken out solely in the student’s name, and the student is responsible for repaying them — not the parents.

The major difference between unsubsidized and subsidized loans is interest, according to Jill Desjean, senior policy analyst with the National Association of Student Financial Aid Administrators. The government allocates money, or a subsidy, to cover interest on subsidized loans while the borrower is an active student.

“The student is not responsible for interest [on subsidized loans] while they’re in school or their grace periods,” Desjean says. This helps them save money upfront. Interest resumes once the borrower’s grace period ends, usually six months after graduation.

On the other hand, unsubsidized loans start incurring interest right away. Interest accumulates from the day the student takes out the loan, even if they are not required to make active minimum payments on the principal amount. Any undergraduate student can qualify for an unsubsidized loan if they’re eligible for federal financial aid, but only undergraduate students with significant financial need can qualify for a subsidized loan. 

“Financial need is determined by the information included on your FAFSA form, “ says Barry Coleman, vice president of counseling and education programs with the National Foundation for Credit Counseling. “Not all students are eligible for Direct Subsidized Loans. In fact, just a small percentage will be. Typically, a lot more are eligible for Unsubsidized Loans.”

Here’s a breakdown of the major differences between Direct Subsidized and Unsubsidized Loans:

Interest on Subsidized vs. Unsubsidized Loans

Interest rates on federal Direct Subsidized Loans and Direct Unsubsidized Loans are set by the government and change every year. For a given type of loan, the rate is the same for every borrower, regardless of the borrower’s credit score, income, or other financial information. You can see the current rates for different types of federal student loans, as well as rates for previous years, on the Federal Student Aid website. 

Although the interest rate is the same on subsidized and unsubsidized loans for undergraduate students, how interest accrues is quite different. 

Direct Subsidized Loans

• Interest rate for loans disbursed between July 1, 2021 and July 1, 2022: 3.73%

With Direct Subsidized Loans, interest doesn’t accrue while you’re in college, during your grace period — the six months after you graduate, leave school or drop below half-time status — or any periods of deferment. 

Direct Unsubsidized Loans

• Interest rate for loans disbursed between July 1, 2021 and July 1, 2022: 
  • Undergraduate: 3.73%
  • Graduate: 5.28%

By contrast, interest starts to build right after your Direct Unsubsidized Loan is disbursed, so paying off your student loan debt can take longer — and be more expensive. 

Due to emergency COVID-19 relief measures set by the U.S. Department of Education, the interest rate on most federal student loans (including Direct Unsubsidized and Direct Subsidized Loans) is 0% until May 1, 2022. Loan payments have also been suspended during this time. 

Pros and Cons of Direct Subsidized Loans

The core benefit of Direct Subsidized Loans is how interest is handled. With the Department of Education covering your interest charges during certain periods, less interest will accrue and your total repayment cost will be lower. 

Direct Subsidized Loans are a good option for undergraduates because they have low interest rates and are eligible for income-driven repayment plans. They’re also qualifying loans for Public Service Loan Forgiveness and Teacher Loan Forgiveness, so borrowers could qualify for loan forgiveness if they work for a qualifying non-profit, government agency, or school.

However, Direct Subsidized Loans aren’t available to everyone. Only students with exceptional financial needs will qualify for Subsidized Loans. Even if you qualify, you will likely need other loans to pay for the full cost of your tuition because the annual and aggregate limits on Subsidized Loans are quite low. 

Pros

• Interest doesn’t occur during certain periods

• Low interest rates

• Eligible for multiple repayment plans

• Qualifying loan for loan forgiveness

Cons

• Limited to undergraduate students with significant financial need

• Low annual and aggregate borrowing maximums

• Origination fees apply

Pros and Cons of Direct Unsubsidized Loans

Unlike Direct Subsidized Loans, which are only for lower-income undergraduate students, Direct Unsubsidized Loans are for both undergraduate and graduate students, regardless of financial need. 

Unsubsidized loans have relatively low interest rates.  The rate is 5.28% for graduate borrowers and the same rate as subsidized loans for undergraduate borrowers (3.73%). In addition, unsubsidized loans have higher annual and aggregate borrower maximums. 

Direct Unsubsidized loans share many of the same benefits as Direct Subsidized Loans, including income-driven repayment plans and the potential for loan forgiveness. However, the borrower is responsible for all interest that accrues on unsubsidized loans, starting immediately as soon as the loan is disbursed. Interest is also capitalized, meaning the amount of accrued interest is added to your principal at certain times, such as the end of your grace period. Interest then accrues on the new higher balance, causing your balance to grow faster. Over time, interest capitalization can increase your total repayment cost. 

Pros

• No credit checks

• Low interest rates

• Higher borrower limits

• Eligible for multiple repayment plans, as well as loan forgiveness under certain circumstances

Cons

• Borrower is responsible for all interest

• Graduate students pay higher interest rates

• Interest is capitalized

Are Subsidized or Unsubsidized Loans Better?

When it comes to subsidized and unsubsidized loans, subsidized loans are the clear winner. If you can qualify for them, you’ll pay less money in interest charges with a subsidized loan, and you’ll save money over the life of your loan. 

But not everyone will qualify for a subsidized loan. Students are often eligible for unsubsidized loans only, or they must use a combination of the two to meet the full cost of college. Unsubsidized loans could be a better choice than other financing options like private student loans because they’re eligible for federal benefits like: 

• Income-Driven Repayment (IDR): Once your loans are in repayment, you can enroll in an IDR plan. These plans base your payments on a longer term and a percentage of your discretionary income, so you could significantly lower your payment amount. 
• Loan Forgiveness: Federal loans are eligible for forgiveness programs like Public Service Loan Forgiveness, Teacher Loan Forgiveness and IDR plan forgiveness. 
• Loan Discharge: Federal loans can be discharged if you are totally and permanently disabled. 
• Forbearance or Deferment: If you return to school, lose your job, or become seriously ill, you can temporarily pause your federal loan payments. 

By contrast, private student loans aren’t eligible for those protections, and they usually have much higher interest rates than federal Direct Loans. The Institute for College Access & Success reported that the average fixed interest rate for co-signed private loans was 10.2% for 2019 — the last available data. 

“With private loans, it’s possible that someone with very good credit or a co-signer may get a better interest rate,” Desjean says. “However, private loans don’t have the same protections as federal loans.”

Who Qualifies for Direct Subsidized Loans?

To qualify for any kind of federal student aid, including Direct Subsidized and Unsubsidized Loans, you must meet the following criteria, according to the Federal Student Aid website: 

• You must be a U.S. citizen, permanent resident or eligible noncitizen
• You must have a valid Social Security number (Exceptions apply if you’re from the Republic of the Marshall Islands, Federated States of Micronesia or the Republic of Palau.)
• You must be enrolled in a degree or certificate program at an eligible school 
• You must be enrolled at least half-time
• You must be eligible for college by earning a high school diploma, GED or other recognized equivalent

Subsidized loans are only issued to those with demonstrated financial need. To apply, you must fill out and submit the FAFSA. Based on that information, the government will calculate your expected family contribution (EFC) and share it with your selected colleges. The college then uses the EFC to develop your financial aid package, and will determine if you are eligible for grants, work-study programs, and subsidized or unsubsidized loans. 

When exploring financial aid, start early (perhaps before your senior year of high school), and make sure you consider all available options. 

“We recommend that students first maximize all the grants and scholarships they can get,” Coleman says. “Next in line, we recommend subsidized loans, followed by unsubsidized loans. Those options would come before considering anything else, like private loans.”

You can start the process by filling out the FAFSA online at www.FAFSA.gov.