Subsidized vs. Unsubsidized Loans

ByG. Dautovic
April 26, 2022

College financing for those who weren’t lucky enough to get a full ride one way or another means the need to take out federal student loans. These fall into one of two categories: Subsidized vs. unsubsidized loans. You may have heard these terms thrown around previously or are somewhat aware of what they mean, but we imagine you still have some questions.

There is one main difference between these loans: The borrower pays the interest on a direct unsubsidized loan at all times; direct subsidized loans have their interest paid by the institution issuing them, for the duration of the borrower’s studies, the grace period, and any deferments.

Still, there is much more to know about subsidized and unsubsidized loans before you can choose which is right for you.

Subsidized Loans

If you’ve managed to get your hands on a subsidized loan, and are enrolled in school at least half time, the government will be paying the interest on your subsidized loan. They’ll also cover the interest on your loan if you’ve graduated or your loans are in deferment or forbearance.

Whatever is left of the interest once all these periods expire, will be added to the principal amount of the loan, and you’ll pay it off.

Another one of the pros of subsidized federal student loans is the eligibility period: You can be in school and have your interest covered by the government for 150% of the formal length of the college program you’re enrolled in.

On the flip side, there are several cons of subsidized federal student loans to know about. For one, you can’t qualify for subsidized loans as a graduate student, nor will you be eligible if you can’t prove that you need financial assistance. Also, annual loan limits are lower for subsidized versus unsubsidized loans.

Ultimately, if you are an undergraduate student from a lower-income household, this loan is for you. The school you’re planning to attend will determine the amount of direct subsidized loans you’re eligible for.

Unsubsidized Loans

Now, it’s time to cover direct unsubsidized loans. These are also federal loans, and you’ll find out if you’re eligible for them by completing the FAFSA. This form will ask for information about your income, assets, and those of your parents.

The primary difference here is that your eligibility for direct unsubsidized loans isn’t based on financial need. You’re also going to be responsible for paying interest on this type of loan while in school or when the loans are in deferment after graduating.

If, for any reason, you don’t make the interest payments, that amount will get added to your loan balance. Therefore, repayment will be more costly in the end.

As for the pros of unsubsidized student loans, they are as follows:

  • Undergraduate and graduate students can apply for a direct unsubsidized loan.
  • You don’t need to prove financial hardship to qualify.
  • Loan limits are always lower for a subsidized vs. an unsubsidized loan.
  • At the cost of adding the accrued interest to your principal, you can defer payments until six months post-graduation.
  • There’s no time limit on your eligibility period for this type of borrowing.

There aren’t many cons of unsubsidized student loans, but the one there is, is pretty big: You’ll be paying it all back yourself, and you’ll have more interest to cover.

Loan Similarities

Differences are not the only thing relevant to the subsidized vs. unsubsidized loans debate: For example, the amount you’re allowed to borrow for both types will be determined by your school. According to the Department of Education, the current interest rate for undergraduate unsubsidized and subsidized loans is fixed at 3.73%, and the fees are the same for both loan types.

Repayment Priorities

Your loan repayment will be all about organization, and experts recommend always repaying your unsubsidized loans before direct subsidized loans. Unless you plan on paying the interest while in school on an unsubsidized loan, these will have a higher balance because they have been accruing interest.

Even if you have just a subsidized loan, and much of your interest was paid off by the government, you should make a student loan repayment strategy after college so you can become debt-free as soon as possible.

Main Takeaways

So, how do subsidized and unsubsidized loans compare? Here are the main takeaways:

  • Federal student loans can be subsidized or unsubsidized.
  • Loan limits are different for undergraduate and graduate students.
  • Eligibility for subsidized loans is based on financial need.
  • The government makes the interest payments on subsidized loans during your studies, grace period, and deferments.
  • Interest rates for private loans are always higher than for federal student loans.

Both types of loans can help you pay for college, but they’re still loans, and you’ll need to pay them back eventually. You should think carefully about how much you’ll need to borrow and think of an actionable repayment plan.

How to Qualify for Federal Direct Loans

No matter which loan type you choose, you must meet the following requirements as a borrower:

  • Be enrolled at least half-time at a school that participates in the Federal Direct Loan program
  • Have a US citizenship or eligible non-citizenship
  • Possess a valid Social Security number (SSN)
  • Have satisfactory academic progress
  • Have a high school diploma or equivalent
  • Have zero defaults on any existing federal loans

Private Student Loans

Another option to consider here is private student loans. As you look at your financial options, always think about taking advantage of grant or scholarship opportunities first. If borrowing money is your only option, it’s almost always best to begin with federal loans. 

There are several benefits unique to federal government loans. For instance, there are loan forgiveness options, income-driven repayment plans, and long forbearance and deferment periods. Unfortunately, you may end up needing to finance your education, or at least part of it, through private loans, but this should only be a last resort. The upside is that, if you have good credit, you may qualify for a low interest rate.

FAQ

Which is better, unsubsidized or subsidized loans?

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Direct subsidized loans are always the best choice - if you can get them. This is because the government will be paying your interest while you’re in school, during grace periods, and deferments.

Do you have to pay back subsidized loans?

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Yes, you’ll still have to make payments even on subsidized loans, but only after you’re out of school. While you can pay back your subsidized loan at any time, the loan payment is required six months after graduation, and most students choose this option. Your loan will enter the repayment phase at this time, and your loan servicer will place you on the Standard Repayment Plan.

This will set up your repayment term at up to 10 years, with equal payments every month. However, you can always make changes to your payment plan based on your needs.

Can my loan ever be forgiven or discharged?

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There is one attractive perk to receiving subsidized and unsubsidized student loans, which is access to PSLF. With PSLF, any student loan debt remaining after 120 qualifying payments can be forgiven tax-free. Also, the loans eligible for Teacher Loan Forgiveness include subsidized and unsubsidized direct federal loans.

What’s more, any outstanding balance on your loan will be forgiven if you haven't repaid your loan in full after 20 years for undergraduate study, or after 25 years if the loans were taken out for graduate or professional study.

Should I accept the unsubsidized loan?

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While the answer here depends on your circumstances, there are some best practices to keep in mind. If you do accept it, only borrow as much as you need and start repaying it as soon as possible. Also, always make sure there’s absolutely no way to get a subsidized loan first, because that’s always the better option.

About author

I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.

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