Subsidized vs Unsubsidized Student Loans: What Are the Differences?

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Subsidized and unsubsidized loans are part of the federal student aid program that helps students afford the costs of higher education. The main difference between the two federal loan types is the way interest accrues. Students do not have to pay the interest accrued on Direct Subsidized Loans while in school or during deferment or forbearance. In contrast, students are responsible for the interest accrued on Direct Unsubsidized Loans once disbursed. Understanding the differences between these loans can help you decide how best to afford college. Here's what you need to know.

What's the Difference Between Subsidized and Unsubsidized Loans?

If you submit the Free Application for Federal Student Aid (FAFSA), you can qualify for both federal subsidized and unsubsidized loans. However, what you qualify for and the amount of aid you receive will depend on your finances and school costs.

Direct Subsidized Loans are only available to undergraduate students with demonstrated financial need, and the government covers the interest while the student is in school or files for deferment or forbearance. Meanwhile, Direct Unsubsidized Loans are available to both undergraduate and graduate students without the requirement of demonstrating financial need, and the borrower is responsible for paying the interest costs during all periods.

For both loan types, your school determines how much you can borrow. With Direct Subsidized Loans, the amount you are awarded must not exceed your financial need. For Direct Unsubsidized Loans, the amount you're awarded is based on your cost of attendance and any other financial aid you receive. Below, you can find more specifics about these loans to help you understand the pros and cons of each type.

What Is a Subsidized Loan?

A Direct Subsidized Loan is a federal loan in which the government covers the interest while the student is enrolled at least half-time in an eligible school. The government will also cover the interest on your subsidized loans during the grace period after graduation and in cases where you apply for deferment or forbearance. In order to qualify, you will need to demonstrate financial need through your FAFSA form, which is based on your cost of attendance and your expected family contribution (EFC). Each school will decide whether you qualify and the amount of your subsidized loans.

Pros of Subsidized Loans

Subsidized loans are a great option for students with financial need, as the government pays the interest on your loan during school, deferment and forbearance as long as you are enrolled at half-time status. This means that if you take out $20,000, your loan balance will be the same amount upon graduating. In addition, if you are enrolled in certain income-driven repayment (IDR) plans and unable to cover your interest charges, the government will provide assistance and cover a portion or all of your interest charges.

Cons of Subsidized Loans

Subsidized loans aren't a good fit for everyone. Students who are in graduate school or can't demonstrate financial need aren't eligible for these loans. The amount you can borrow is also limited to $23,000 for undergraduate dependent students, which means you may have to borrow more to cover all your school costs. Undergraduate students can only borrow $34,500 in unsubsidized loans if they use borrow up to the maximum for subsidized loans.

What Is an Unsubsidized Loan?

A Direct Unsubsidized Loan is a federal loan available to both undergraduate and graduate students. Unlike Direct Subsidized Loans, there is no requirement to demonstrate financial need. But similar to subsidized loans, your school determines the amount you can borrow. However, the amount you can borrow is based on your school's cost of attendance and the other financial aid you receive.

Pros of Unsubsidized Loans

Direct Unsubsidized Loans are available for both undergraduate and graduate students, and borrowers don't need to prove financial hardship to qualify. Your school will still decide how much you qualify for, which can make up the difference in what you didn't get from Direct Subsidized Loans. Annual loan limits for these loans are $31,000, which is $8,000 more than the loan limits for Direct Subsidized Loans.

Cons of Unsubsidized Loans

Unlike Direct Subsidized Loans, borrowers are responsible for paying all the interest on Direct Unsubsidized Loans once they are disbursed. Student loan borrowers typically wait until they graduate to start paying off their loans, which means interest will build while you're in school, growing to a larger loan balance than the amount you borrowed. Even during the grace period after graduation and if you file for deferment or forbearance, interest will continue to accrue and you will be responsible for paying that on top of your principal balance.

What Are the Similarities Between Subsidized and Unsubsidized Loans?

Although there are major differences between these two loans, Direct Subsidized and Direct Unsubsidized Loans also have quite a few similarities. Most notably, both loans carry the same interest rate of 5.05% for undergraduate students and loan fee of 1.062%. So, although Direct Subsidized Loan borrowers won't have to pay interest during school, deferment and forbearance, they will pay the same interest rate at all other times.

For both types of loans, your school will determine the amount for which you're eligible. Each school you apply to will give you a financial aid package that details the grants, scholarships, and subsidized and unsubsidized student loans for which you qualify. You will only be allowed to borrow up to the amount stated on your financial aid package for both loan types.

Alternative Options to Consider

If you've maxed out all of your federal options and still fall short of your school costs, we've listed the other student aid options available to you. Keep in mind that you should try to limit the amount of debt you take on and always look for the lowest interest rates available.

Grants and Scholarships

Grants and scholarships are a great way to get funding for school, as you won't have to pay back the money. You should check out these options even before you take out loans because it can help lower the debt you take on. Grants tend to be need-based, while scholarships are usually merit-based. Take the time to explore your options from the government, your state, your school, and other organizations and companies that offer grants and scholarships.

Other Federal Student Loans

If you use up your federal options, you still have some federal loans to consider. If you are a graduate student or your What is a Parent PLUS Loan? wants to take out debt for your school costs, you can apply for a Direct PLUS Loan, as long as you don't have an adverse credit history and you meet the eligibility requirements for federal student aid. Direct PLUS Loans have a higher interest rate and loan fee compared to Direct Subsidized and Unsubsidized Loans, with the current interest rate at 7.6% and a loan fee of 4.248%. If you have good credit history, consider using a private lender, as you might qualify for a lower interest rate.

Private Student Loans

Borrowers should only consider private student loans after receiving aid through the FAFSA, as most federal student loans tend to have better interest rates and repayment options. However, if you or your co-signer have a great credit history, you may qualify for better interest rates from private student loan lenders than from a Direct PLUS Loan. Many lenders will allow you to borrow up to 100% of your school's cost of attendance and may offer multiple repayment terms and plans. However, be sure to look at lender and loan servicer reviews before choosing to go with a private lender.

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