Subsidized vs. unsubsidized student loans: What you need to know

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If you take out federal student loans to pay for college, they will fall into one of two broad categories: subsidized or unsubsidized. The major difference between the two is that Direct Subsidized Loans don’t charge borrowers interest during certain periods of deferment, while Direct Unsubsidized Loans charge interest for the duration.

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 (FAFSA), your school sends you a financial aid award letter that explains what you qualify for and how much you can borrow.

Here’s how subsidized and unsubsidized student loans work:

Direct Unsubsidized Loans
Direct Subsidized Loans
Who pays interest costs? The borrower While the student is enrolled, during grace periods and during deferment: The U.S. Department of Education
During normal repayment and forbearances: The borrower
What’s the aggregate maximum limit? Dependent undergraduate students: $31,000
Independent undergraduate students: $57,500
Graduate students: $138,500
Undergraduate students (dependent and independent): $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? Loan fee: 1.057% for loans disbursed on or after Oct. 1, 2020, and before Oct. 1, 2022 Loan fee: 1.057% for loans disbursed on or after Oct. 1, 2020, and before Oct. 1, 2022
What is the maximum eligibility period? No limit No limit for first-time borrowers on or after July 1, 2021

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 less expensive than Direct Unsubsidized Loans because interest doesn’t accrue on them during certain time frames. The U.S. Department of Education pays interest on subsidized loans while the borrower is enrolled at least half time in school, during a six-month grace period after graduation and during deferment periods.

Pros of subsidized federal student loans

  • The government will pay the loan interest while the student meets enrollment requirements, during a six-month grace period and during deferment periods.
  • The borrower doesn’t need to go through a credit check.
  • A co-signer is not required.
  • The interest rate is fixed and often lower than private student loan rates.
  • Borrowers having difficulty repaying the loan can ask for payments to be postponed.
  • Income-driven repayment options may be available.
  • All or part of the loan might be eligible for forgiveness under certain circumstances.

Cons of subsidized federal student loans

  • The borrower has to demonstrate financial need, and a parent’s income and assets might disqualify a student from receiving a subsidized loan.
  • Graduate and professional students are not eligible.
  • Borrowing limits are lower, and the student might have to supplement with other loans.
  • Unpaid loan balances don’t go away in bankruptcies.

What is an unsubsidized loan?

A Direct Unsubsidized Loan is a type of federal student loan that starts accruing interest as soon as money is disbursed to your school. You may choose not to pay this interest while you’re in school and during your six-month grace period, but any unpaid interest that accumulates during this time will be added to your total balance.

Pros of unsubsidized student loans

  • Undergraduate, graduate and professional students are eligible.
  • Unsubsidized loans come with higher loan limits than subsidized loans.
  • Borrowers and families don’t need to demonstrate financial need to qualify.
  • It’s possible to defer payments for up to six months after graduating or leaving school (though interest will accrue).
  • The loans include federal student loan benefits, like multiple repayment options.
  • No credit check is required.

Cons of unsubsidized student loans

  • Unsubsidized loans accrue interest from the time of disbursement, even while you’re in school.
  • If the borrower doesn’t pay the interest when it accrues, it will capitalize (meaning the lender adds it to the principal loan balance).
  • Unpaid loan balances can’t be discharged in bankruptcy.

How much can you borrow?

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

However, there are annual and aggregate limits on how much you can borrow with both types of loans.

  • Dependent students can borrow a total of $31,000 for undergraduate studies for both unsubsidized and subsidized loans. A maximum of $23,000 can come from Direct Subsidized Loans.
  • Independent undergraduate students can borrow up to $57,500 total. A maximum of $23,000 can come from Direct Subsidized Loans.
  • Graduate or professional students can borrow a total of $138,500 in Direct Unsubsidized Loans, including any undergraduate loans.

Interest rates on subsidized and unsubsidized loans

The federal government sets federal student loan interest rates, and the rates may change each school year. For the 2021-22 academic year, the interest rates are:

  • 3.73 percent for undergraduate students who take out Direct Unsubsidized or Direct Subsidized Loans.
  • 5.28 percent for graduate and professional-degree students who take out Direct 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, though unsubsidized loans will accrue interest. Upon graduating, dropping below half-time enrollment or leaving school, 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, 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.

Should I take out federal or private student loans?

As you consider how to pay for college, it’s wise to take advantage of any grant or scholarship opportunities available to you before you start to look at financing options. If you do have to borrow money, it’s almost always best to start with federal loans. These loans come with many benefits unique to the federal government, like income-driven repayment plans, long forbearance and deferment periods and loan forgiveness options.

If grants, scholarships and federal loans don’t cover your costs, you may need to stack on private student loans to finance the remaining balance. While these should typically be a last resort, you may qualify for low interest rates if you have good credit.

How the Biden presidency affects federal student loans

Since the beginning of the coronavirus pandemic in March 2020, the U.S. Department of Education has made a series of moves to provide temporary relief to federal student loan borrowers.

These actions include suspending loan payments and implementing a 0 percent interest rate on all government-owned loans. Collections activities have also been halted on defaulted federal loans. After a series of extensions, this forbearance period is currently set to expire on Sept. 30, 2021. Some experts think that Biden will extend the forbearance period into 2022.

If you have an eligible federal student loan, your loan is automatically placed into this administrative forbearance. However, you are still able to make payments on your loan if you wish; doing so will cut down your debt faster, since all payments will be going toward the principal.

Additionally, the Biden administration has helped cancel loans for borrowers defrauded by their college and waive the income tax on forgiven student loan amounts through the end of 2025. Some of his other proposals include revising income-driven repayment plans and making Public Service Loan Forgiveness easier to qualify for.

Frequently asked questions about federal student loans

What additional steps are there to receive my loan?

Start by heading to the U.S. Department of Education’s website to fill out the FAFSA (Free Application for Federal Student Aid) each year. Once the department processes your application (generally within three to 10 days, depending on how you apply), you’ll receive a Student Aid Report (SAR).

The SAR details your expected family contribution (EFC) and goes to the school(s) you listed on your FAFSA application. Your school will tell you which types of loans you qualify for and the amounts you are approved to borrow. If a federal student loan is part of your total financial aid package, your school’s financial aid administrators can tell you how to accept the loan.

How will I receive my loan?

When your loan is disbursed, your school will take out sufficient funds to pay for tuition, room and board and any other fees. If there is any money remaining from your loan proceeds, your school’s financial aid office will refund it to you within 14 days. Remember, funding from student loans can only be used for legitimate educational expenses.

What types of loan repayment options are there?

Federal student loans feature a number of repayment options. This payment flexibility is one of the key perks federal student loans have to offer borrowers.

  • Standard Repayment Plan: Your payments will be fixed over a 10-year period (or 10 to 30 years on Direct Consolidation Loans). All borrowers are eligible.
  • Graduated Repayment Plan: Your payments will start low and gradually increase. All borrowers are eligible. There is a 10-year payment term (or 10 to 30 years for Direct Consolidation Loans), and the total interest paid over the life of the loan will be higher than on the standard plan.
  • Extended Repayment Plan: Borrowers with more than $30,000 in Direct Loans can have payments extended to 25 years, and the payments can be fixed or graduated.
  • Revised Pay As You Earn Repayment Plan (REPAYE Plan): Monthly payments are 10 percent of your discretionary income over 20 or 25 years. Your payments are based on your income and family size (which must be updated every year). Student borrowers with qualifying Direct Loans are eligible.
  • Pay As You Earn Repayment Plan (PAYE Plan): Monthly payments are 10 percent of your discretionary income over a 20-year term. However, your payment amount cannot be higher than it would be if you were under the Standard Repayment Plan. Your monthly payment is based on income and family size, which must be updated annually. This option is available for new student borrowers on or after Oct. 1, 2007, who received a disbursement of a Direct Loan on or after Oct. 1, 2011.
  • Income-Based Repayment Plan (IBR Plan): Payments are 10 or 15 percent of your discretionary income and will not be more than what you would pay under the standard plan. The repayment term is either 20 or 25 years, depending on when you took out your loan. Your income and family size factor into your repayment and must be updated each year. Student borrowers with qualifying Direct or FFEL Program loans are eligible.
  • Income-Contingent Repayment Plan (ICR Plan): Your payment will be the lesser of either 20 percent of your discretionary income or what you would pay on a repayment plan with a fixed payment over the course of 12 years. The repayment term is 25 years. Payments are based on income, family size and the amount of your Direct Loans. All borrowers with qualifying Direct Loans are eligible.
  • Income-Sensitive Repayment Plan: Your annual income determines the amount of your monthly repayment, which can move up and down each year. Monthly payments span a maximum of 15 years. Borrowers with FFEL Program loans are eligible.

Can my loan ever be forgiven or discharged?

There are several ways a federal student loan can be forgiven or discharged.

  • Eligible loans can be forgiven through the Public Service Loan Forgiveness program, industry-specific forgiveness programs (for teachers, nurses, doctors, etc.) and income-driven repayment plans.
  • You might be eligible for a student loan discharge for a variety of reasons. Discharge opportunities include Closed School Discharge, Perkins Loan Cancellation and Discharge, Total and Permanent Disability Discharge, Discharge Due to Death, Borrower Defense to Repayment, False Certification Discharge, Identity Theft Discharge and Unpaid Refund Discharge. You can learn more and apply for a federal student loan discharge on the U.S. Department of Education website.

Can I cancel my loan if I don’t need it?

It is possible to cancel your federal student loan, but only if you act quickly. You can cancel all or part of your loan within 120 days of when your school paid out your loan. As long as you return the funds you borrowed before the cutoff date, you won’t be responsible for interest or loan fees.

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Written by
Kim Porter
Contributing writer
Kim Porter is a personal finance expert who loves talking budgets, credit cards and student loans. In addition to serving as a contributing writer for Bankrate, Porter also writes for publications such as U.S. News & World Report, Credit Karma and Reviewed.com. When she's not writing or reading, you can usually find her planning a trip or training for her next race.
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