Should your loan be subsidized or unsubsidized? Read this before borrowing.

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If you’re like most prospective students, you have questions about your loan options. When it comes to student loan interest, Direct Subsidized Loans are better for students than Direct Unsubsidized Loans.

Interest on subsidized loans does not accrue during enrollment plus six months afterward. Interest on unsubsidized loans accrues during enrollment, but you don’t have to pay it until later.

Technically, the federal government pays the interest accrued on subsidized student loans during enrollment. However, from a student’s perspective, there is basically no interest while you are enrolled at least half-time plus six months thereafter.

Also, eligibility requirements for both types of loans are slightly different.

Before the federal Direct Loan program, the government used to give out Stafford Loans. These loans (named after Robert Stafford) were available as subsidized or unsubsidized. Ten years ago, Congress replaced this Stafford Program with the Federal Direct Student Loan Program.

Disclaimer: Although I am a student loan lawyer, this article contains general information and should not be taken as legal advice. If you want legal advice that pertains to your specific situation, you should schedule a free consultation with me.

Differences in subsidized vs. unsubsidized loans

What is the difference between subsidized and unsubsidized loans? The main difference between subsidized and unsubsidized loans is that you don’t accrue interest during enrollment on subsidized loans. However, eligibility for each type of loan varies as well.

There are some key differences between federal Direct subsidized and federal Direct unsubsidized loans, including:

  • Interest accrual
  • Who is eligible
  • Interest rate
  • Borrowing limits
  • Fees
  • Repayment

What is better, subsidized or unsubsidized loans? Subsidized loans are better than unsubsidized loans because you don’t have to pay for any interest that accrues during your enrollment plus the 6-month grace period after finishing.

However, you can borrow more money with unsubsidized loans.

Interest accrual

How loan interest accrues is the most significant difference between subsidized and unsubsidized student loans.

For subsidized loans, the federal government pays the accrued interest while you’re enrolled in school, plus during a 6-month grace period after you are not enrolled. This grace period applies whether you graduated or left. Also, interest does not accrue during periods of deferment.

From the student’s perspective, no interest accrues during your enrollment period plus the six-month grace period.

For unsubsidized loans, interest accrues on your loan during periods of enrollment, deferment, and forbearance. There is no grace period of interest accrual. However, you may choose not to pay the interest during your enrollment plus a six-month grace period.

If you do not pay the interest on an unsubsidized loan while you’re in school, that unpaid interest will be capitalized. This means the interest will be added to the principal amount, and then interest will accrue on that interest.

Who is eligible

Undergraduate students are eligible for both subsidized and unsubsidized loans. Graduate students are only eligible for unsubsidized loans issued at a higher interest rate than undergraduate loans.

What are the requirements for subsidized loans? The requirements for subsidized loans include the following:

  • Financial need
  • Undergraduate student status
  • At least half-time enrollment

One key requirement for subsidized loans is that students have to “demonstrate financial need.” There is no such requirement for unsubsidized loans.

To be eligible for both types of loans, you must maintain at least half-time enrollment in a school that participates in the Direct Loan Program (which is most accredited schools).

As of July 1, 2021, there is no maximum amount of time for which you can borrow subsidized student loans.

However, between 2013 and 2021, you could only take out subsidized loans for 150% of your degree program’s published length. For example, if you were enrolled in a 4-year program in 2018, you could only take out subsidized loans for 6 years (4 years x 150%).

After that period, you could still take out unsubsidized loans. For new borrowers, of course, this is now a moot point.

Interest rate

Interest rates are generally the same between subsidized and unsubsidized student loans.

However, the interest rate on subsidized loans is effectively 0% while enrolled, plus the six-month grace period. Technically speaking, the interest is accruing, but the U.S. Department of Education is paying it.

Borrowing Limits

Loan borrowers can take out different loan amounts depending if the loan is subsidized or unsubsidized. This is the second most prominent difference between the two types of federal higher education loans.

The total loan amount that you can borrow in federal student loans (subsidized and unsubsidized) depends on 2 factors:

  • Your academic year
  • Whether you are dependent or independent

Being “dependent” means that your parent or guardian claims you on their taxes as a dependent.

If you are a dependent student, but your parents cannot take out a Parent PLUS loan (also called Direct PLUS loan), you are considered an independent student.

If you are a graduate or professional degree student, you are considered an independent student.

Here’s how much a dependent undergraduate student can borrow each school year:

  • First-year students can borrow $5,500. Only $3,500 of that can be subsidized loans due to annual loan limits.
  • Second-year students can borrow $6,500. Only $4,500 of that can be subsidized loans.
  • In your third year and beyond, students can borrow $7,500/year. Only $5,500/year of that can be subsidized loans.
  • Altogether, dependent students can borrow up to a $31,000 aggregate loan limit throughout their student careers. Only $23,000 of that can be subsidized.

Here’s how much an independent student can borrow each school year:

  • First-year students can borrow $9,500. Only $3,500 can be subsidized loans.
  • Second-year students can borrow $10,500. Only $4,500 can be subsidized loans.
  • In your third year and beyond, students can borrow $12,500/year. Only $5,500/year of that can be subsidized loans.
  • Graduate and professional students can borrow $20,500 in unsubsidized loans. These students cannot receive subsidized loans as of 2012.
  • Altogether, independent undergraduate students can borrow up to $57,500 throughout their student careers. Only $23,000 of that can be subsidized.
  • Altogether, graduate and professional degree students can borrow up to a $138,500 loan limit. Only $65,500 of that amount can be subsidized. These amounts include all loans from the graduate student’s time as an undergraduate.

Fees

Both subsidized and unsubsidized student loans have a loan fee. This origination fee for new loans is currently 1.057%, which is deducted from each loan disbursement.

The interest accrued during enrollment for unsubsidized loans may be seen as a fee, but it is not called by that term.

Repayment

Student loan repayment for both subsidized and unsubsidized loans must begin by the time the 6-month grace period ends after enrollment ceases.

However, unsubsidized loans accrue interest during enrollment (unlike subsidized loans). So, it is often wise to start repayment on unsubsidized loans as soon as possible to avoid interest capitalization. When interest capitalizes, new interest builds on the old interest.

Either way, your lender will contact you during the six-month grace period after you drop below half-time enrollment, letting you know how much you owe in loan payments, as well as your first due date.

Both subsidized and unsubsidized loans are eligible for all federal repayment plans, including IBR, PAYE, and REPAYE.

Do you have to pay back a subsidized loan? Yes, you have to pay back a subsidized loan. It’s still a loan. The “subsidized” part refers to the federal government paying the interest that accrues during your enrollment period plus the six-month grace period.

How to apply for subsidized and unsubsidized student loans

To apply for a subsidized or unsubsidized federal loan, fill out the Free Application for Federal Student Aid form (FAFSA).

Your school uses your FAFSA form to determine how much federal student aid you qualify for, based on the cost of attendance minus expected family contribution. In a financial aid award letter, the school will tell you how much student aid you are eligible to receive.

There is no difference between applying for subsidized loans and applying for unsubsidized loans. When you fill out the FAFSA, your school will tell you what you qualify for in terms of subsidized and unsubsidized loans. There’s really not anything else you can do.

First-time borrowers need to sign the master promissory note and go through entrance counseling most of the time.

What do you need in order to get a subsidized loan? You need to demonstrate a financial need to qualify for a subsidized loan. There is no such requirement to qualify for unsubsidized loans.

Federal loans vs. private loans

Federal loans can be subsidized or unsubsidized. However, most private loans are unsubsidized, meaning you will accrue interest while you’re enrolled in whatever school you attend.

Benefits of federal loans

Federal loans have many benefits for borrowers and are often the first choice for many students. Here’s why:

  • Federal loans may be subsidized, meaning you accrue no interest while at school.
  • You may qualify for income-driven repayment options.
  • You’re eligible for loan forgiveness programs.
  • You don’t need a cosigner.

Benefits of private loans

Private loans can be a suitable option for some borrowers with excellent credit or those who don’t meet federal requirements. Here are the upsides of private loans:

  • You can often borrow more money.
  • Private loan companies cannot garnish your wages without a court order if you don’t pay.
  • You’re more likely to be able to settle the debt if you default.

Repaying Student Loans: Which Should You Prioritize?

Prioritize paying off your largest student loan first. Alternatively, you could pay off your highest interest rate student loan first.

If you have multiple federal student loans, you may want to consider student loan consolidation or refinancing for private student loans.

Personally, I recommend paying off private student loans before federal student loans — if not only because the government seems likely to forgive a bunch of federal student loan debt within the next 10 years.

Handle your student loans for good.

What are the benefits of subsidized loans? The main benefit of subsidized loans is that you don’t have to pay the interest that accrues during enrollment or deferment periods. The main downside is that you can’t borrow as much as you can with unsubsidized loans.

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