Disclaimer: This article is for informational purposes only. It should not be considered legal or financial advice. You should consult an attorney or other financial professional to determine what is best for your individual needs.
A college education in the US may be expensive, but thanks to federal student loans, it is still accessible to many American students. The only problem: It can be difficult to know which student loans to choose from, mainly subsidized versus unsubsidized student loans.
If you are not sure what to borrow or the difference between these types of student loans, you have come to the right place. Read on to learn more about subsidized and unsubsidized student loans.
What are subsidized student loans?
A subsidized student loanalso called a direct subsidized loan, is a federal student loan available to undergraduate students if they have sufficient financial need.
Being subsidized means that interest rates are temporarily paid or stopped by the government, and are generally much lower than unsubsidized loans. This allows students to focus on education without worrying about interest accruing on them for some of their terms.
More specifically, the U.S. Department of Education pays all interest on subsidized student loans as long as the borrower is enrolled in school for at least half the time. This arrangement lasts six months after graduation and during other applicable deferral periods.
What are unsubsidized student loans?
An unsubsidized student loan is also a type of federal student loan. But unlike subsidized loans, interest rates for unsubsidized loans begin to rise once the money is distributed to a borrower’s school.
However, this does not mean that students have to pay the interest right away. Students can choose not to pay the interest while in school and during a six-month grace period after graduation. However, unpaid interest accumulates during this time and is continually added to the borrower’s total balance.
Key Differences Between Subsidized and unsubsidized student loans
In summary, interest on subsidized student loans is paid by the government while students are in school and for six months after graduation.
At no point does the government pay interest on unsubsidized student loans, so it consistently accrues. Graduate students are only eligible for unsubsidized loans, and only in some cases.
However, there are many differences between subsidized and unsubsidized student loans apart from the basic breakdown above. Here’s a closer look at those differences.
Loan limits and qualifications
Directly subsidized student loans have lower annual loan limits than direct unsubsidized loans. For example, freshman dependent undergraduate students can borrow $3,500 in subsidized loans and $5,500 in unsubsidized loans. Both contribute to a total federal student loan limit of $23,000.
In addition, students must demonstrate sufficient financial need to qualify for subsidized forms of loans. You can apply through the FAFSA or Free Application for Federal Student Aid. In contrast, unsubsidized student loans are available to any student borrower regardless of their financial need.
Interest and costs
As mentioned above, the main difference between subsidized and unsubsidized student loans is the way interest is handled. On subsidized student loans, interest is paid by the government for a while, but not on unsubsidized loans.
However, there are also other differences. Subsidized federal student loans have fixed annual percentage rates or APRs of 4.99% for all loans disbursed from July 1, 2022 through June 30, 2023. These apply to loan payments (usually monthly payments) required over the life of the loan.
Unsubsidized federal student loans have fixed APRs of 4.99% for undergraduate loans, 6.54% for graduate or professional student loans, and 7.54% for PLUS loans. These rates apply for the same period as subsidized loans.
Meanwhile, subsidized and unsubsidized loans fees of 1.057% for all loans disbursed between October 1, 2020 and October 1, 2021.
Grace periods and delay
Subsidized and unsubsidized federal student loans have six-month grace periods or deferral periods, meaning student loan repayments do not begin until six months after graduation.
However, interest on unsubsidized loans is capitalized, meaning it is added to the original amount borrowed. That’s because, as mentioned above, the federal government doesn’t pay interest costs for unsubsidized student loans.
Unfortunately, this can lead to a spiraling and costly effect. For example, the larger the principal balance, the more each successive interest charge adds to the stack. Therefore, prospective students should be careful about using too many unsubsidized federal student loans.
In terms of deferrals, the Department of Education pays interest on all subsidized loans during deferral periods, such as the recent one for Covid-19. Unsubsidized loans, of course, are collected during the deferral.
Recently, the US government released a student loan debt relief program. US citizens may be eligible for loan forgiveness. However, this program is currently blocked.
How much money can you borrow?
Now that you know the major differences between subsidized and unsubsidized student loans, you may be wondering what the maximum amount you can borrow is.
Dependent freshman students can borrow $5500 in student loans, of which no more than $3,500 can be subsidized. Independent students, meanwhile, can borrow up to $9,500. Again, there can only be up to $3,500 in subsidized loans.
The loan rate increases for each subsequent grade. Here’s a breakdown:
- Dependent sophomore undergraduate students: $4,500 in subsidized loans, $6,500 in total.
- Independent sophomore undergraduate students: $4,500 in subsidized loans, $10,500 in total.
- Dependent third-year and higher students: $5,500 in subsidized loans, $7,500 in total.
- Independent Third Year and Later Students: $5,500 in subsidized loans, $12,500 in total.
As you can see, the federal government only allows you to take out a certain amount of loans per year. If you have more financial needs, you should seek financial aid through scholarships, grants, or loans from private lenders or other institutions.
Which one should you use: subsidized or unsubsidized student loans?
Given all this information, you might ask yourself if you should prioritize subsidized unsubsidized student loans.
For most American students, the answer is obvious: subsidized student loans are superior because you don’t have to worry about accruing interest while you’re in school and during any grace or deferral periods.
This way, you pay less for subsidized loans over their term than unsubsidized loans. However, you can’t take out as much money in federal direct subsidized loans as you can in unsubsidized loans.
The most followed strategy is this:
- Apply for as many federal student-subsidized loans as possible. Withdraw as much money as possible through this system as it is the most cost-effective way to pay for your education and benefits from abundant repayment options.
- Then, only if you still need a little more money, take out additional unsubsidized federal student loans for the remainder of the academic year to pay for the cost of attendance.
- You can also pursue other forms of financial aid such as scholarships, grants and other low interest rate loans from secondary financial institutions and lenders such as banks or credit unions.
Doing so will wipe out as much of your future interest payments as possible and walk away with as much financial backing as possible.
Related: Don’t Be a Victim: 4 Ways You Can Take Charge of Your Student Loans
Do you need the federal or private student loans?
Given the potentially high cost of unsubsidized federal student loans, some students may wonder if private loans are better.
It is almost always better to borrow federally first. Why? Private loans, even those offered by reliable financial institutions, usually have higher interest rates. They also usually require cosigners if student borrowers have no credit history, which is very common for new students.
Related: Private and Federal Student Loans for College: Which Works Best for Your Child?
Meanwhile, subsidized and unsubsidized federal student loans offer more forgiveness and refinancing options, borrower repayment plans, and additional flexibility compared to private loans.
At worst, if you can’t pay your loans and have a ton of student debt, you’ll have an easier time getting things done with federal student loans than private student loans.
You should only use private student loans if you need to fill unexpected arrears to cover college costs or if you find an excellent deal with a low interest rate. In that case, a private student loan might be a little cheaper than an unsubsidized student loan, but that’s rare.
In many ways, subsidized student loans can be superior to unsubsidized loans. Still, both can enable you to pursue a college degree and open up new professional paths for your future.
If you qualify for student loans, it may be best to take them, provided you plan to pay them back once you graduate. In addition, consult your university’s financial aid office for more personalized guidance.
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