Subsidized vs. Unsubsidized Student Loans

According to The Institute for College Access & Success (TICAS), 65 percent of college seniors who graduated from college in 2017 needed to rely on an average of $28,650 in student loan debt in order to afford their college education.

With tuition and fees, room and board, books, meal plans, and other college expenses costing an average of more than $20,700 each year, it’s easy to understand why. That is simply too much for most students (and their families) to afford out of pocket.

While you likely know that the first step to receiving financial aid—including student loans—is to complete the Free Application for Federal Student Aid (FAFSA), what you might not know is that federal student loans come in a number of different varieties. Depending on your specific financial situation, you might even be offered multiple different types of student loans within your financial aid package.

Two of the most common federal student loan varieties are: Direct Subsidized Loans and Direct Unsubsidized Loans.

While these loans might sound extremely similar (there is, after all, only a two-letter difference between the names), the truth is that they are very different. That difference is so great that it could translate into thousands of dollars in extra interest payments over the life of a loan.

Below, we discuss the similarities and differences between subsidized and unsubsidized federal student loans so that you can make smart financial decisions about which student loans you accept from your financial aid package, as well as which loans you might want to prioritize paying off.

Subsidized vs. unsubsidized student loans: a snapshot

Subsidized and unsubsidized student loans are both types of student loans that are offered directly to college students from the federal government. This means that the specifics of both types of loan (including interest rates, fees, maximum borrowing limits, eligibility requirements, etc.) are governed by law.

Despite these similarities, a number of important differences exist between subsidized and unsubsidized student loans. The most significant of these differences is the way in which interest accrues on the loan.

Direct Subsidized Loans are student loans available to undergraduate students who demonstrate a significant amount of financial need, where the federal government covers the interest that accrues on the principal under certain conditions:

• When you are enrolled in college at least half-time
  
  

• During your grace period: This is the first six months after you leave school due to graduation, dropping out, or falling below half-time status, during which you are not required to make payments.
  
  

• When your loan is placed in deferment
  
  

By paying for the interest that accrues on your principal during this time, the Department of Education is subsidizing your education (hence the name).

Direct Unsubsidized Loans, on the other hand, accrue interest as you would expect from any other type of loan. As soon as the loan is disbursed, the principal will begin to accrue interest—regardless of whether or not you are actively enrolled in college or if your loan is in its grace period or deferment.

If you are unable to pay this interest as it accrues, it will be capitalized (or added to the principal), at which point the interest will begin accruing interest of its own.

The difference in action

To demonstrate the difference that this makes, consider two borrowers who each take out a $3,500 federal student loan during their first year of college. Both loans carry an interest rate of 4.53 percent and both are repaid according a standard 10-year epayment plan. The only difference is that Borrower A’s loan is subsidized, while Borrower B’s loan is unsubsidized.

Borrower A’s loan does not accrue any interest while they are enrolled in school, which prevents its balance from rising. After graduation, they begin making payments of $36.32 per month. Borrower A will repay a total of $4,358—$858 of which would be interest.

Borrower B’s loan, on the other hand, does accrue interest for the four years that they are enrolled in school—about $634 worth. When they graduate, they are unable to pay the interest that has accrued, so it capitalizes and is added to their principal, bringing their new loan balance to $4,134. In this case, Borrower B would make payments of $42.90 per month, and would repay a total of $5,148. That’s $790 more than Borrower A had to pay.

Now let’s imagine that both borrowers are unable to begin making payments immediately after graduation. Both borrowers make use of their six-month grace period and then place their loans into deferment for a period of 12 months.

In this scenario, Borrower A’s loan balance will remain at $3,500, and they will repay a total of $4,358 over the life of the loan. Borrower B’s loan balance will grow to $4,420, and they will repay $5,504 over the life of the loan. That’s a difference of more than $1,100.

How do subsidized student loans work?

Interest Rates

Direct Subsidized Loans disbursed between July 1, 2019 and July 1, 2020 carry an interest rate of 4.53 percent. These rates are fixed (they will not change over the life of the loan) and are set annually by Congress.

As mentioned above, any interest that accrues on your loan when you are enrolled at least half time as an undergraduate student, when your loan is in its grace period, or during periods of deferment will be covered by the federal government. If your loan is in active repayment or in forbearance (when you need to temporarily pause your payments because of financial reasons), it will accrue interest.

Fees

Direct Subsidized Loans disbursed between October 1, 2018 and October 1, 2019 carry a loan fee of 1.062 percent. Those disbursed between October 1, 2019 and October 1, 2020 carry a loan fee of 1.059 percent. Loans disbursed before October 1, 2018 carry a different fee depending on exactly when they were disbursed.

Who qualifies for a Direct Subsidized Loan?

In order to qualify for a Direct Subsidized Loan, you must submit the FAFSA application. Because there is a limited amount of funding available each year for subsidized student loans, only those applicants who demonstrate a certain level of financial need will be eligible for these loans.

Beyond this, you must be enrolled as an undergraduate student at least half-time at a qualifying educational institution. You do not need to pass a credit check or have a cosigner to qualify.

What are the maximum subsidized loan amounts?

As of 2019, over the course of your entire undergraduate career you can borrow a total of $23,000 in subsidized student loans (if eligible). The exact amounts that you can borrow each year vary:

First Year: $3,500

Second Year: $4,500

Third Year and Beyond: $5,500

How do unsubsidized student loans work?

Interest Rate

Direct Unsubsidized Loans disbursed to undergraduate students between July 1, 2019 and July 1, 2020 carry an interest rate of 4.53 percent. Those disbursed to graduate or professional students carry an interest rate of 6.08 percent. These rates are fixed (they will not change over the life of the loan) and are determined annually by Congress.

Unlike subsidized student loans, unsubsidized loans will accrue interest when you are enrolled in school, when your loan is in its grace period, and during periods of deferment, forbearance, or repayment. If you are unable to pay the interest that has accrued, it will capitalize and be added to your loan principal.

Fees

Direct Unsubsidized Loans disbursed between October 1, 2018 and October 1, 2019 carry a loan fee of 1.062 percent. Those disbursed between October 1, 2019 and October 1, 2020 carry a loan fee of 1.059 percent. Loans disbursed before October 1, 2018 carry a different fee depending on exactly when they were disbursed.

Who qualifies for a Direct Unsubsidized Loan?

In order to qualify for a Direct Unsubsidized Loan, you must submit the FAFSA application. Unlike subsidized loans, unsubsidized loans do not require you to demonstrate financial need. They are available to undergraduate, graduate, and professional students, regardless of credit history or score.

What are the maximum unsubsidized loan amounts?

As with subsidized student loans, there is a maximum amount of unsubsidized student loan debt that you can carry. The exact amount will depend on the degree that you are pursuing (undergraduate, graduate, professional) as well as your status as a dependent (in the case of undergraduate students.

All totals mentioned below are current as of 2019.

Dependent undergraduate students may borrow a total of $31,000 in unsubsidized student loans over the course of their undergraduate career. If they have qualified for the maximum of $23,000 in subsidized student loans, then they can borrow a total of $8,000 in unsubsidized student loans.

The exact amounts that you can borrow each year vary:

First Year: $5,500

Second Year: $6,500

Third Year and Beyond: $7,500

Independent undergraduate students may borrow a total of $57,500 in unsubsidized student loans over the course of their undergraduate career. If they have qualified for the maximum of $23,000 in subsidized student loans, then they can borrow a total of $34,500 in unsubsidized student loans.

The exact amounts that you can borrow each year vary:

First Year: $9,500

Second Year: $10,500

Third Year and Beyond: $12,500

Graduate and professional students may borrow a total of $138,500 in unsubsidized student loans over the course of their entire educational career (undergraduate and graduate/professional). You can borrow a total of $20,500 in unsubsidized student loans each year of your graduate or professional studies.

So, what’s preferable—subsidized or unsubsidized student loans?

As you can see, subsidized federal student loans carry significant benefits compared to unsubsidized student loans. If you are eligible to receive both types of loans, you should accept the subsidized loans first.

That being said, both subsidized and unsubsidized student loans are preferable to private student loans, as they will typically carry a lower interest rate and come with greater borrower protections compared to what is available from private lenders.

If you have both subsidized and unsubsidized federal student loans, it is generally recommended that you do your best to make interest-only payments on your unsubsidized loans while you are a student, during your grace period, or during periods of deferment or forbearance. Doing so will allow you to avoid interest capitalization and prevent your loan balance from growing.

Similarly, because unsubsidized student loans carry fewer benefits compared to subsidized student loans, it is generally recommended that you prioritize using any extra funds in your budget to pay off your unsubsidized student loans first, before turning your attention to subsidized student loans.