Editor’s Note: In response to the coronavirus pandemic, as of March 13, 2020, the Trump Administration has halted interest payments on federal student loans. Please note that this applies to federally held student loans only and may not apply to your private student loans. Also note that student loan payments are still required, however your entire payment will now be made toward the principal of the loan. Check with your student loan provider for more information.
These days, the cost of post-secondary education is prohibitively expensive for many students. That’s why in 2017, Americans had 1.48 trillion dollars in student loan debt.
The fact is, the majority of students pursuing higher education will need to take out a student loan – probably more than one.
Unfortunately, some students don’t take the time to really explore their options when it comes to financing their education. I get it; the different types of loans can be confusing, and sometimes it’s hard to know what the right move is.
The type of loan(s) you take can affect how interest works, the overall amount you end up paying, and how to best manage repayment.
That’s why it’s important to talk about subsidized vs. unsubsidized student loans. What they are, how they differ, and why you’d choose one over the other. Let’s do it!
Subsidized vs. Unsubsidized Student Loans: The Similarities
Subsidized and unsubsidized student loans are federal loans offered by the U.S. Department of Education to help students finance higher education.
The government offers direct subsidized and unsubsidized loans through the Direct Loan Program. To be eligible for either, you must be enrolled at a post-secondary institution that participates in the program. For both types of loans, your school determines how much you’re eligible to borrow.
Note that the terms “direct subsidized loan”, “subsidized student loan”, and “direct Stafford loan” all refer to the same thing. The same applies for the terms “direct unsubsidized loan” and “unsubsidized student loan”. I’m just throwing that out there so you don’t get confused if you see one loan product being called three different names.
Here’s how the two types of loans are similar:
To apply for either a direct subsidized loan or a direct unsubsidized loan, students have to complete a Free Application for Federal Student Aid (FAFSA).
When comparing subsidized vs. unsubsidized loans, interest rates for undergraduate students are the same: 5.05%. This rate is current for the 2018-2019 academic year. It’s a pretty low rate, and it’s fixed, meaning it won’t change over the term of the loan.
Both types of loans come with the same loan fee. For loans first extended on or after October 1, 2017, but before October 1, 2018, the fee was 1.066%. For loans extended on or after October 1, 2018, but before October 1, 2019, you’re looking at 1.062%. So, whether you have a direct subsidized loan or a direct unsubsidized loan, you can expect just over 1% to be deducted from your disbursement.
Subsidized vs. Unsubsidized Student Loans: How are They Different?
While subsidized and unsubsidized loans share some similarities, there are some key differences, too.
Direct subsidized loans are only available to undergraduate students who can demonstrate financial need. Your school determines how much you can borrow based on your financial need and your educational expenses.
Unlike direct subsidized loans, unsubsidized loans are available to undergraduate, graduate, and professional program students.
Your school still determines the amount you’re eligible to borrow, but unlike direct subsidized loans, it isn’t based on financial need. Instead, it’s based on the cost of attendance at your school. In these ways, unsubsidized student loans have more flexible eligibility criteria.
The main appeal of a direct subsidized loan is that the government temporarily pays the interest. That’s what is meant by “subsidized.” Good things can’t last forever, though. They’ll pay your interest to FedLoan or Navient while you’re in school (as long as you’re registered for at least half-time) and for the first six months after you leave school or graduate. They also cover interest during a period of deferment.
The interest relief during school and for the six-month grace period is a huge benefit for students and new grads in financial need.
Not having to make interest payments while studying might be the difference between being able to focus on classes and having to take on extra part-time work to pay the bills.
And while I know you hope to start making a decent income straight out of school, it doesn’t always happen that way. Depending on your major, the job market where you live, and plain old-fashioned luck, it might take you a while to find a job after graduating. Not having to worry about your student loan interest while you’re trying to find a job and get on your feet can be a huge relief.
Unsubsidized loans don’t come with the same interest relief perks as direct subsidized loans.
In fact, they don’t come with any. You don’t even get a break while you’re in school – interest applies from the get-go. If you choose not to pay the interest (or can’t pay it) during these times, it will be added to your principal.
Interest Rates for Grad Students
Another point about interest: If you’re in graduate school or a professional program, be aware that the interest rate for direct unsubsidized loans will be higher for you than for undergraduates. For both subsidized and unsubsidized loans, undergrads pay 5.05%. Graduate and professional students, however, pay 6.60%.
Time Limit on Loan
After July 1, 2013, the maximum amount of time you can receive a direct subsidized loan is 150% of the length of your program. Note that means the published length of the program, not how long it takes you as an individual.
For example, if you’re enrolled in a four-year bachelor’s degree program, 150% of that would be six years. So, you wouldn’t be able to receive a direct subsidized loan for any longer than that.
Unsubsidized loans are not subject to the same restriction.
Subsidized vs. Unsubsidized Student Loans: Amount You Can Borrow
There are annual limits on how much you can borrow through the Direct Loans Program, as well as an aggregate loan limit. Dependent and independent students have different limits (independent students can borrow more). The thing is, only so much of what you borrow can be from a direct subsidized loan.
For dependent undergrads, the aggregate direct loan limit is $31,000, only $23,000 of which can be subsidized. For independent undergrads, it’s $57,500, but again, no more than $23,00 can be from a direct unsubsidized loan.
What this amounts to is that if you’re pursuing a direct subsidized loan, the total amount you can borrow is $23,000. If you need more than that, you can consider unsubsidized loans.
Subsidized vs. Unsubsidized Student Loans: Pros and Cons of Each
To summarize, here are the key pros and cons of subsidized and unsubsidized student loans:
Pros of a Direct Subsidized Loan
- You don’t pay interest while you’re in school as long as you’re enrolled at least half-time.
- The government also covers your interest payments during the six-month grace period after you leave school.
- You’re not responsible for interest payments if your loan is in deferment.
Essentially, the biggest benefit of a direct subsidized loan is the fact that the U.S. government makes your interest payments until six months after you finish school. That’s a win in my book.
Cons of a Direct Subsidized Loan
- Only undergrads are eligible. So, if you’re a graduate student or pursuing a professional program, a direct subsidized loan isn’t an option for you.
- The onus is on the applicant to demonstrate financial need. Your parents’ income may be considered when assessing your application, and if they earn too much, you won’t qualify.
- You can borrow less money through a direct subsidized loan than you can through an unsubsidized loan.
Pros of a Direct Unsubsidized Loan
- Eligibility criteria are more flexible – undergraduate, graduate, and professional program students are welcome to apply.
- No need to prove financial hardship.
- You can borrow more money.
Cons of a Direct Unsubsidized Loan
- No interest relief. The government doesn’t cover any of your interest payments, not even while you’re in school.
Subsidized vs. Unsubsidized Student Loans: Which Should I Pay Back First?
If you don’t consolidate your loans, it’s usually best to pay back your unsubsidized loans first. Here’s why: If you don’t make your interest payments while you’re in school, they get added to your principal. That means when you graduate and tackle repaying that loan, the balance has grown. You’re now paying interest on a higher balance.
With a direct subsidized loan, the government pays your interest while you study, so your post-school loan balance doesn’t grow. So, if you had both types of loan, each for the same original amount, the unsubsidized loan would cost you more when you start repaying it. For that reason, it makes sense to try to pay it down first.
Of course, after school, it typically makes sense to either consolidate your loans or refinance them through a private lender. (Websites like Credible can help.) This will save you the hassle of having to make separate payments on each individual loan.
Additionally, refinancing may also be able to help you get a lower monthly payment and/or interest rate. Be careful, though. If you plan to use certain federal benefits like Income-Based Repayment (IBR) or the Public Service Student Loan Forgiveness (PSLF) Program, doing a private refinance may make you ineligible.
For more information, you can find some of this month’s best student loan refinance rates here.