Difference Between Subsidized and Unsubsidized Student Loans

When it comes to paying for college, many financial options are available to help students cover the costs of tuition, room and board, books, and other education-related expenses. Different types of financial aid include grants, scholarships, federal work-study, and student loans — both federal and private.

Students have access to two types of loans — subsidized and unsubsidized. Understanding the difference between the two types is important when applying for and receiving loans, as it impacts the amount you can borrow and how you plan to repay the loan.

In this guide, we break down the differences and similarities between subsidized and unsubsidized loans so you can make an educated decision.

Subsidized vs. Unsubsidized Loans: The Basics

Direct Subsidized Loans and Direct Unsubsidized Loans are available through the U.S. government’s Federal Student Aid office. However, private lenders like banks also offer unsubsidized student loans.

Direct subsidized loans are only available to undergraduate students with a demonstrated financial need, enrolled at least part-time; unsubsidized loans are available to undergraduate and graduate students, and eligibility is not need-based.

To determine eligibility for Direct Subsidized and Direct Unsubsidized Loans from the federal government, students must complete the Free Application for Federal Student Aid (FAFSA) which officially opens in late December this year. Unsubsidized loans from private lenders have their own application processes and eligibility criteria.

The difference between subsidized and unsubsidized loans

*You can pay the interest on an unsubsidized student loan while in school or request deferral of interest payments until after graduation. If you defer the payments until after graduation, the interest amount is added to the principal, increasing the total balance of the loan amount that collects interest and is due after graduation.

Recognizing the importance of interest accrual

Interest is the fee a bank or lender charges you to borrow their money. It is usually calculated as a percentage of the original amount, or principal, that you borrowed. Regardless of the loan type, interest accrues once you’re approved.

The main difference between subsidized and unsubsidized loans is who pays the interest that accrues while you are in school, or the loan is in a grace period, deferment, or forbearance.

With direct subsidized loans, the federal government pays any interest that accrues on the loan while the student is in school. That means the amount you borrow as a freshman is the same balance you are expected to repay upon graduation.

With unsubsidized loans, the student is responsible for paying the interest even while enrolled in school, whether from a private lender or the federal government. The balance of this type of loan increases immediately, so making at least the monthly interest payments is recommended. Students can apply to defer the interest payments until graduation, but those are added to the principal amount of the loan.

Here’s an example of how this works:

If a student borrows $10,000 in loans every year for four years at a rate of 6.5% and a term length of 10 years, the balance at graduation would be $45,541. That’s more than $5,000 in interest alone. If the student pays the interest while they’re in school, the amount will remain the original $40,000.

Taking into consideration loan amounts and fees

The U.S. government determines the maximum loan amount you can borrow for subsidized and unsubsidized loans based on your answers on the FAFSA. For undergraduate students, the maximum loan amount is based on the year you request the loan — for example, whether you are a first-year or second-year student.

There are fees associated with processing student loan applications as well, which are also determined by the U.S. Department of Education. These fees are a percentage of the total loan amount, and that percentage can increase or decrease every year. Because the percentage changes, the fees are deducted from each loan disbursement. So, the amount that is disbursed will be lower than the amount borrowed. However, you are responsible for paying back the borrowed amount before fees are deducted.

The U.S. Department of Education periodically reviews these amounts to ensure that maximum loan amounts allowed, the interest rates, and the fees associated with student loans are adequate to accommodate both students and lenders.

Understanding the qualification requirements

To qualify for subsidized loans, you must be enrolled in an approved undergraduate program and participate in the Direct Loan Program at least part-time. A student’s dependency status — whether you are a dependent or independent student — is also important.

Dependent students’ financial need is reviewed based on their parents’ or guardians’ income. If you still live with your parents or are under the age of majority for your state, you are most likely considered a dependent student. While a parent’s or guardian’s income may be too high to qualify a student for a subsidized student loan, they would still qualify for an unsubsidized loan.

Independent students have specific characteristics showing they are financially independent of their parents or guardians, such as being at least 24 years old or emancipated, married, have dependents, or are graduate students.

Making a plan for repayment

After graduation, your loan servicer will send you information on how much you will need to pay per month to stay current with your loan repayment obligation. You must make repaying your student loans a priority.

If you are able to make extra payments, they certainly help you repay the loan faster. Apply those extra payments to any unsubsidized loans first, as those accrued interest while you were in school, making your overall loan repayment amount higher than when you started school.

Below is an example of how making extra payments can save you money:

A student has $40,000 in student loans when they graduate. The interest rate is 6.5%. At a normal monthly payment of $350 per month, it will take almost 15 years to pay off the loans, and the total interest accrued starting at graduation will be $22,528.

If you add just an extra $150 per month to this payment, it would shorten the payoff time to 8 years and 10 months and save around $10,000 in interest.

Pros and Cons of Subsidized and Unsubsidized Loans

If you are an undergraduate student who has the choice between subsidized and unsubsidized loans, there are some advantages and disadvantages to each that you and your family should consider:

Direct Subsidized Loan

Direct Unsubsidized Loan

Private Unsubsidized Loan

Subsidized vs. Unsubsidized Loans: At-A-Glance

Frequently Asked Questions About Subsidized and Unsubsidized Student Loans

Additional Student Loan Resources

• StudentAid.Ed.Gov
• Free Application for Federal Student Aid (FAFSA)
• StudentAid.gov
• Consumer Financial Protection Bureau
• Federal Trade Commission
• Debt.org

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