What’s the difference between subsidized and unsubsidized student loans?

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When you take out federal student loans to pay for college, your loans are either unsubsidized or subsidized. The main difference between the two comes down to who pays interest. During certain time frames, the Department of Education covers interest costs for borrowers who qualify for Direct Subsidized Loans. Borrowers who get Direct Unsubsidized Loans must cover all interest costs. Understanding the difference between subsidized and unsubsidized loans is important because it impacts how you pay interest, your total debt after graduation and how you handle repayment.

Subsidized vs. unsubsidized loans

Both Direct Subsidized and Direct Unsubsidized Loans are part of the federal Direct Loan program. When you submit the Free Application for Federal Student Aid, your school sends you a financial aid letter that explains what you qualify for and how much you can borrow. Here’s how subsidized versus unsubsidized student loans work.

Unsubsidized Loans
Subsidized Loans
Who pays interest costs? The borrower is responsible for paying all interest costs The Department of Education pays interest while the student is enrolled in school, during the six-month post-graduation grace period and during deferment. The borrower pays interest during regular repayment periods.
What’s the lifetime maximum limit? Undergraduate students: up to $31,000
Independent undergraduate students: $57,500
Graduate students: $138,500
Undergraduate students: Up to $23,000
What do you need to qualify? Does not require proof of financial need Must demonstrate financial need
Who can borrow? Undergraduate students, graduate students and professional degree students Undergraduate students
Are there extra costs involved? The borrower pays a loan fee of 1.059% for loans disbursed before Oct. 1, 2020 The borrower pays a loan fee of 1.059% for loans disbursed before Oct. 1, 2020

What is a subsidized loan?

A Direct Subsidized Loan is a type of federal student loan that undergraduate students can receive by showing financial need. They’re cheaper than unsubsidized student loans because interest doesn’t accrue on them during certain time frames. The Department of Education pays interest on Subsidized Loans in these cases:

  • While the borrower is enrolled at least half time in school.
  • For a six-month grace period after graduation.
  • During deferment periods.

You’ll shoulder the interest costs once you start repaying the loan. While these loans won’t cost as much in interest as an Unsubsidized Loan, they come with a couple of drawbacks. Subsidized Loans have lower loan limits, and not everyone qualifies for them.

What is an unsubsidized loan?

A Direct Unsubsidized Loan is another type of federal student loan. Unlike a Subsidized Loan, an Unsubsidized Loan starts accruing interest as soon as money is disbursed to your school. Although you can defer payments while you’re in school and in some other cases, interest builds and will later be added to your principal balance.

The upside to these loans: They come with higher loan limits than Subsidized Loans, and you don’t have to demonstrate financial need to qualify.

How much can you borrow?

Your school decides how much you can borrow based on your cost of attendance, year in school and any other financial aid you receive.

However, The Department of Education sets annual and lifetime limits on how much you can borrow with both types of loans. You may borrow up to $31,000 total throughout your undergraduate education using an Unsubsidized Loan, or $57,000 if you’re considered independent for tax purposes, and only $23,000 of those limits may come from Subsidized Loans. The lifetime limit is $138,500 for graduate students, and no more than $65,500 can come from Subsidized Loans.

Interest rates on subsidized and unsubsidized loans

Federal student loan interest rates are set by the federal government and may change each school year. They’re based on the type of degree you’re seeking. For the 2020-21 academic year, the interest rates are:

  • 2.75 percent for undergraduate students who take out Unsubsidized or Subsidized Loans.
  • 4.3 percent for graduate and professional-degree students who take out Unsubsidized Loans.

What does the repayment process look like?

Federal student loan borrowers — whether they have Subsidized or Unsubsidized Loans — don’t have to make payments while they’re in school. Upon graduation, borrowers enter a six-month “grace period.” Interest continues accruing on Unsubsidized Loans but not on Subsidized Loans.

Once the six-month period ends, repayment officially begins. No matter which type of loan you have — subsidized or unsubsidized — interest will be included in your monthly student loan payment.

When mapping out your repayment strategy, prioritize your Unsubsidized Loans. Because these accrue interest while you’re in school, your loan balances will continue to grow unless you make interest payments.

The bottom line

Subsidized loans are cheaper because you won’t pay interest while you’re in school, during the post-graduation grace period and while in deferment or forbearance. However, only borrowers who demonstrate financial need are eligible. Head to the Department of Education’s website to fill out the FAFSA each year. Your school will take the information you provide and tell you which type of loan you qualify for.

Featured image by Marcos Mesa Sam Wordley of Shutterstock.

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