Borrowing for College? Why to Choose Subsidized vs. Unsubsidized Loans
Understanding the difference between subsidized vs. unsubsidized student loans could help you save a bundle in debt.
But considering how much they have in common, it’s understandable if you have trouble telling them apart (especially since they also go by other names — we’ll explain in a bit).
Both loans are part of the federal government’s financial aid offerings, designed to help students cover the cost of college.
Although unsubsidized claims a larger portion of outstanding direct loans — $528.5 billion compared to $282.9 billion in subsidized loans as of the first quarter of 2020 — there’s plenty of overlap among borrowers who take out both types.
We’ll explain the difference between the two loans and how each can affect your finances long after you finish your final exams.
Subsidized vs. Unsubsidized Student Loans
If you’ve applied for financial aid, it’s likely you’ve seen references to direct loans, Stafford loans and direct Stafford loans. What’s the difference?
The answer: nothing.
The federal student loans for undergraduate students are called direct subsidized and direct unsubsidized loans (which are different from Parent or Graduate Plus loans, consolidated loans and the now-defunct Perkins loans).
Congress renamed the direct student loan program in 1988 to honor U.S. Senator Robert Stafford for his work on higher education; now direct loans also go by the names Stafford loans or direct Stafford loans.
So if you’re reading up on student loans (or reviewing your financial aid award letter), remember:
- Direct subsidized loan = subsidized Stafford loan = direct subsidized Stafford loan.
- Direct unsubsidized loan = unsubsidized Stafford loan = direct unsubsidized Stafford loan.
Got that? Good, now onto explaining the important differences (and similarities) between subsidized and unsubsidized loans.
Tale of the Tape: Subsidized vs. Unsubsidized Student Loans
A side-by-side comparison of subsidized and unsubsidized loans is probably the easiest way to see the differences — we’ll get into the details after:
|Who qualifies for a loan?||Undergraduate students with financial need.||Undergraduate and graduate students (no financial need requirements).|
|How much can I borrow?||Limited by your financial need, dependency status and year in school. If you reach the limit, you’ll qualify for unsubsidized loans.||Limited by the cost of attendance at your school, dependency status and year in school. If you reach the limit, you will need to find another source of money (such as private student loans).|
|Is there a time limit? (For first-time borrowers after July 1, 2013.)||The maximum eligibility period is 150% of the published length of your program (example: for a four-year degree, the maximum is six years).||No time limit.|
|Who pays the interest while I’m in school, during grace periods and during deferment periods?||The government.||You.|
Based on this chart, the winner is subsidized loans (if you don’t know why, check that last row: any option that includes someone else paying your bills is a winner). But let’s find out exactly why you should choose subsidized loans whenever you’re given the option.
Why Subsidized Loans Are Better Than Unsubsidized Loans: They Save You Money
If you have a subsidized loan, the federal government pays the interest on loans when you’re in school at least half-time, during the six-month grace period after you leave school and during deferments.
If you have an unsubsidized loan, not only will the interest pile up each year of college but it will continue accruing during your grace period, at which point the interest capitalizes.
Confused? Let’s look at an (admittedly simplified) example:
Sara and John each apply for student loans for their junior and senior years of college.
Both years, they each receive $5,000 loans with a 3% interest rate.
But Sara qualifies for a subsidized loan while John gets an unsubsidized loan.
If you lose eligibility for subsidized student loans but stay enrolled in your current program, you’ll become responsible for paying the interest on any subsidized loans you previously took out.
On graduation day, Sara owes $10,000 (junior + senior year loans) because the government paid the interest on her loan while she was in college. John owes $10,000, plus $450 in interest ($150 in interest on the loan he took out senior year plus two year’s worth of interest — $300 — for the loan he took out junior year).
If Sara and John take advantage of the grace period, Sara will begin accruing interest on the original $10,000 when she starts repaying her loans. John will accrue interest on his new total, $10,600, when he starts repaying his loans (his original $10,000 in loans plus $450 in interest he accrued by graduation day plus another $150 in interest during the six-month grace period).
Why Subsidized Loans Are Harder to Get
If you look at the example and think, “This is a no-brainer: subsidized loans all the way!” — yeah, consider this a hard lesson in reality.
The only way to get subsidized loans is if your college’s financial aid office determines you can’t afford to pay the cost of attending that school.
Although the formulas can get a little complicated — and vary by school — here’s a basic way for finding out how much you can get in subsidized and unsubsidized loans:
- Cost of attendance (COA) – expected family contribution (EFC) = need-based aid (including scholarships, grants, work-study programs and subsidized loans)
- Cost of attendance – financial aid you’ve already been awarded (including need-based aid and merit-based scholarships) = unsubsidized loan
The financial aid office at your college decides how much financial aid you are eligible to receive, so if you think there’s an error or you would like to appeal, you should contact them.
How Much Money Can You Get?
If you’re starting your first year of college, you won’t be eligible for as much loan money as when you’re a junior or senior.
And if you’re an independent student, you’ll qualify for more loans than if you’re still claimed by your parents.
All of this is to say, there are a lot of variables that go into how much loan money you can get each year.
On the low end, if you’re a dependent student in your first year, the direct subsidized loan limit is $3,500 while the direct unsubsidized loan limit is $2,000.
If you’re in college and hold both subsidized and unsubsidized loans, try to start paying back unsubsidized loan interest first to avoid as much interest capitalization as possible when you graduate.
On the high end, if you’re an independent student in your third year or beyond, the direct subsidized loan limit is $5,500, and the direct unsubsidized loan limit is $2,000.
And if you’re a graduate or professional student, the annual direct unsubsidized loan limit is $20,500 (remember, you can’t get subsidized loans as a grad student).
You can find out the exact loan limits for your year by checking out the Department of Education’s loan limit tables.
What Do Subsidized and Unsubsidized Loans Have In Common?
Although the differences between subsidized and unsubsidized student loans make a big difference financially, there are some similarities the loans share, including the following.
The colleges that you apply to will use your FAFSA form to decide your financial aid eligibility.
To receive either type of direct loan, you must be enrolled at least half-time in school in a program that leads to a degree or a certificate.
Interest Rates (for Undergrads)
Each year, the federal government sets the interest rates for all undergraduate student loans.
For direct student loans disbursed between July 1, 2020, and July 1, 2021, the undergraduate interest rate is 2.75%.
For graduate students, the interest rate on unsubsidized loans is 4.3%.
Whenever a subsidized or unsubsidized loan is disbursed, a loan fee is deducted from the amount. The fee is calculated as a percentage based on when you took out your loan.
For loans disbursed on or after Oct. 1, 2019, and before Oct. 1, 2020, the loan fee is 1.059%. If you took out a $3,000 loan, for example, the fee would be $31.77, so you’d receive $2,968.23 that term.
Whether it’s subsidized or unsubsidized, your student loan money is sent directly to the school to cover your tuition, fees and room and board every semester, trimester or quarter (depending on your school).
If there is any money left over (or if you’re living off campus), the school will send you a check for the remaining amount within 14 days. For textbooks and other learning materials, the school must provide a way for you to access the funds within seven days of the start of the term.
If you can find your textbooks and class materials for less than the campus bookstore sells them, you can request the check for the remaining amount.
Your school is required to publish the International Standard Book Number (ISBN) for all required texts in the online course schedule. Use this number if you decide to shop for better prices.
If this is the first time you’ve received a direct subsidized or unsubsidized student loan, you should be aware of the following additional restrictions:
- If you’re a first-year undergraduate student and a first-time borrower, the school may wait up to 30 days to give you your loan money. If you need the money before then (for books, for instance), the school should have a policy in place to either provide a bookstore voucher or another way to cover the cost until you receive your loan money.
- The federal government requires you to complete a 30-minute online entrance counseling session before you can accept a loan. Your school may require additional or alternate counseling, so check with the financial aid office first.
Changing Your Mind About a Loan
If you realize that you don’t need your subsidized or unsubsidized loans after all, you may cancel all or part of your loan within 120 days of receiving it without accruing interest or incurring fees.
And if you turned down money but have reconsidered, contact your financial aid office. Most colleges and universities will reinstate an offer for federal student loans included in your original financial aid package.
Subsidized, unsubsidized… it doesn’t matter. The government wants its money back.
When you receive any direct loans, you’ll hear from your loan servicer, who will be your contact if you have questions about your payments or the loan.
Tiffany Wendeln Connors is a staff writer/editor at The Penny Hoarder. Read her bio and other work here, then catch her on Twitter @TiffanyWendeln.
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