June 9, 2017

Subsidized vs Unsubsidized Student Loans


As a college student or graduate, you have many loan terms thrown at you. Among them you'll hear subsidized and unsubsidized loans. What's the difference? Read on.

It might sound like financial jargon, but it determines how much you owe. What if we told you that you could owe less if you have subsidized loans? Interested? Let's learn more here.

What Is a Subsidized Loan?

With a subsidized loan, you won't have to pay for the interest that adds up while you attend school. Sounds like a dream come true, right? Hold on, it's still a loan and you'll still have to pay back what you borrow. It's not free money.

Basically, the Department of Education provides the interest subsidy for financially needy students (we discuss who qualifies below). If you qualify, the DOE pays your interest while you are in school. They may also pay it for the first six months following graduation.

You could still take advantage of the subsidy if you need to defer your student loan payments. When you defer your loans, you stop making payments with the approval of the DOE. This is only temporary. A few reasons you may qualify for deferment include:

  • Unemployment
  • Underemployment
  • Economic hardship
  • Active military service

You don't automatically get to defer a loan, though. You must apply with your loan servicer. If you are having trouble paying your loan, contact them right away.

If you qualify for deferment, the DOE will cover the interest that accrues during that time. Not everyone qualifies for subsidized loans. Read on to see if you are one of them.

Who Qualifies for Subsidized Loans?

Qualification for subsidized loans is done when you apply for aid through FAFSA. The Free Application for Federal Student Aid shows the government your financial situation. This includes your parents' income. The government uses this information to determine what they call your "demonstrated financial need."

In order to calculate this need, the government must know a few other factors:

  • Cost of attendance (COA): This is the total cost for you to attend your chosen school. It includes tuition, room/board, books, supplies, transportation, daily living expenses, and any dependent care.

  • Expected family contribution (EFC): This is based on your family's ability to contribute to your college expenses. It is based on their income, assets, and benefits. (This is a standard percentage of your parents' total income and assets.)

  • Amount of any other financial aid: Any other monetary awards you received figure into the "demonstrated financial need" equation.

Demonstrated Financial Need Equation

COA - EFC = Demonstrated Financial Need

You can't receive more than this number in subsidized loans. But there is an annual maximum you may receive as well. You can't receive more than the lesser of the two numbers. We discuss these maximums below.

Any amount beyond what you receive is considered non-need based aid. This means you received the aid necessary to help you get to college. Now you still may qualify for unsubsidized loans as well as private loans. We talk about these below.

How Long Are You Eligible for Subsidized Loans?

No matter how much you love school and want to continue, you can't receive subsidized loans forever. Any subsidized student loans disbursed after July 1, 2013 have deadlines. This differs from unsubsidized loans, though.

To figure the maximum amount of time you can have subsidized loans, you must know the length of your chosen program. This isn't the time you take to complete it. It's the published length according to your school. Not sure what the published length is for your program? Check your school's catalog or ask your counselor.

Let's look at an example:

You enter your school's 4-year program for your area of study. You have up to 6 years or 150% of the published time to complete the course. If you don't finish within that time, you may still get other loans. You won't be eligible for any more subsidized loans, though.

There's a catch! If you change programs, you are only eligible for the allotted time for that program. It could be longer or shorter. No matter the change, the time you already used up counts towards the new program.

How Much Can You Borrow with a Subsidized Loan?

Along with the published length of the program, there is a maximum amount you may borrow. You may or may not be eligible for the full amount. It depends on your financial situation, as we discussed above.

In general, the following limits apply for direct subsidized loans for undergraduates only:

  • 1st year - $3,500
  • 2nd year - $4,500
  • 3rd year - $5,500
  • 4th year - $5,500

What Are the Loan Fees?

Every direct student loan disbursed incurs a fee. Whether you get a subsidized or unsubsidized loan, you pay the same amount. It is a percentage of your loan amount. The amount you pay depends on the disbursement date of your loan. The difference is negligible, though.

  • Loans disbursed on/after October 1, 2014 but before October 1, 2015 - 1.073%
  • Loans disbursed on/after October 1, 2015 but before October 1, 2016 - 1.068%
  • Loans disbursed on/after October 1, 2016 but before October 1, 2017 - 1.069%

The appropriate fee is deducted from your loan disbursement.

Did you know: The loan disbursement is the money paid to you or your school for college costs. With direct loans, either subsidized or unsubsidized, your school account is funded first. Once your necessary school costs are covered, the remaining funds come to you.

When Do You Start Paying on Subsidized Loans?

Subsidized loans are among those that have a small grace period following graduation. The first six months are payment free. To you they are also interest free. The DOE continues to subsidize your loan for the grace period. After that, you start paying.

If you do nothing, you enter what's called the standard repayment period. This is a 10-year term. You pay principal and interest during this time.

Here's an example:

  • Loan amount: $20,000
  • Interest rate: 5%
  • Estimated monthly payment: $212.13*

*This doesn't include loan fees

For a new graduate, this could eat up a large amount of their monthly salary. Add in rent, groceries, transportation, and daily living expenses, and you could be in trouble.

Can't make the payments? Don't worry. Contact your loan servicer and discuss your loan repayment options. For more information on your options, read our article "How to Get Student Loans Forgiven."

Who Doesn't Qualify for Subsidized Loans?

We talked about demonstrated financial need. It's simple. If your EFC exceeds the cost of attendance, you don't have a need. It gets more complicated, though. Even if you have a need, you may not qualify. Here's who falls into that category:

  • You are a graduate student
  • You don't attend school at least half-time
  • You aren't in a program that leads to a degree or certificate

Good news! Even if you don't qualify for subsidized loans, you can still get unsubsidized loans. Learn more about them below.

The Downside of Subsidized Loans

Subsidized loans sound amazing. No interest for at least a few years? How could you resist? Of course, there are some downsides.

The first of which is that it's a loan you must repay. You have options on how you pay it, though. We discuss them further below. Other downsides are:

  • Not everyone is eligible
  • You probably can't cover your entire cost of education
  • If your parents earn too much, you may not qualify whether they contribute or not

Not eligible for a subsidized loan? Don't worry, you still have options. We discuss them below.

What Are Unsubsidized Loans?

If you reach your subsidized loan maximum or are ineligible, you have options. You can still get unsubsidized loans. Direct subsidized loans offer low, fixed interest rates too. What they don't offer is the interest subsidy. In other words, you pay the interest yourself.

There's a catch here. With subsidized loans, you didn't have to worry about the accrued interest while you were in school. There was interest charged, but you didn't pay it. The government paid it for you. With unsubsidized loans, you don't have that benefit. You pay the interest.

You have two options: pay the interest while you are in school or let it accrue.

If you let the interest accrue, it capitalizes. We look at what this means below.

Capitalizing Interest - What Does That Mean?

Capitalizing interest sounds scary. It's not. Actually, it helps you. It means you don't owe the accrued interest all at once. Instead, the accrued interest is tacked onto your principal balance. You still owe it, but you can take longer paying it back.

How you pay back the principal and interest depends on your current situation. If you can afford the standard repayment plan, your loan will be paid off in 10 years. If you can't, don't worry. There are options. The amount of your income determines how much you pay. Your loan servicer can extend your term based on what you can afford now. The amount you pay may adjust as your income increases.

Understand, though, this increases the amount of interest you pay. The longer you borrow money, the more interest it costs you.

How Unsubsidized Loans Are Different

Subsidized and unsubsidized loans have many similarities. Their interest rate, time you can borrow money, and loan fees are similar. There are some differences that may work to your advantage, though:

  • You can be a graduate student and obtain unsubsidized loans
  • You don't have to prove your financial neediness to obtain the loan
  • You may be able to borrow more

What happens when you maximize your unsubsidized loans? You still have options. Some students turn to private loans.

Private Loans for College Students

Private loans might not sound glamorous. You don't get any subsidies. But you may get more attractive interest rates. If you maxed out your direct loans, you may run into some higher interest rates. Don't discount the benefits of private loans.

Private loans often pick up the slack when you don't get enough from your financial aid. They also often offer different repayment options. With private loans, you can shop around. See what programs different banks offer. Some may offer benefits that exceed what you could get from the government. You won't know until you ask.

Bottom Line

Many college students fund their college education with a combination of government and private loans. Only you know what works for you. We suggest looking at all of your options first. Then you can narrow down what is right for you.

Keep in mind the benefits government loans offer. From loan forgiveness to repayment plans, you have many benefits at your disposal. Exhaust your government-sponsored options and then see what else is available to you.

More from CreditDonkey:


How to Get Rid of Student Loans


Student Loan Forgiveness Scams


Should I Consolidate Student Loans

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