Subsidized vs. Unsubsidized Loans
The rising cost of a college degree has more students than ever borrowing to cover their expenses. While some students opt for loans from private lenders, an estimated 43 million borrowers have federal student loans, as of 2022.
Federal direct loans may be subsidized or unsubsidized. Both types of loans offer numerous benefits, including flexible repayment options, low-interest rates, the option to consolidate loans, and forbearance and deferment programs. But how do subsidized and unsubsidized loans compare? We focus on the key aspects of each type of loan so you can decide what's right for you.
- Federal student loans can be subsidized or unsubsidized.
- A student's eligibility for subsidized loans is based on financial need.
- Although both types of loans have to be paid back with interest, the government makes some of the interest payments on subsidized loans.
- Loan limits are different for undergraduate versus graduate students.
- Interest rates for federal student loans are generally lower than for private loans.
Who Qualifies for Federal Direct Loans?
Federal subsidized and unsubsidized loan borrowers must meet the following requirements:
- Enrollment at least half-time at a school that participates in the Federal Direct Loan Program
- U.S. citizenship or eligible non-citizenship
- Possession of a valid Social Security number (SSN) Satisfactory academic progress
- Possession of a high school diploma or the equivalent
- No default on any existing federal loans
Direct subsidized loans are only available to undergraduates who demonstrate a financial need. Both undergraduates and graduate students can apply for direct unsubsidized loans, and there’s no financial need requirement.
If you qualify for a subsidized loan, the government pays your loan interest while you're in school at least half-time and continues to pay it during a six-month grace period after you leave school. The government will also pay your loan during a period of deferment.
To apply for either type of loan, you will need to fill out the Free Application for Federal Student Aid (FAFSA). This form asks for information about your income and assets and those of your parents. Your school uses your FAFSA to determine which types of loans you qualify for and how much you’re eligible to borrow.
The Biden administration extended federally-held student loan forbearance through Dec. 31, 2022. The White House also announced plans for debt relief for certain borrowers, changes to the student loan system, and plans to cut the costs associated with higher education.
How Much Can You Borrow?
The Federal Direct Loan Program has maximum limits for how much you can borrow annually through a subsidized or unsubsidized loan. There’s also an aggregate borrowing limit.
First-year undergraduate students can borrow a combined $5,500 in subsidized and unsubsidized loans if they’re still financially dependent on their parents. Only $3,500 of that amount may be subsidized loans. Independent students, and dependent students whose parents don’t qualify for Direct PLUS loans, can borrow up to $9,500 for their first year of undergraduate study. Subsidized loans are also limited to $3,500 of that amount.
The borrowing limit increases for each subsequent year of enrollment. The total aggregate subsidized loan limit is $31,000 for dependent students. For independent students, the aggregate limit is raised to $57,500, with the same $23,000 cap on subsidized loans.
Beware of predatory lenders. Large companies have been caught improperly approving loans to those unlikely to repay them and recommending federal loan forbearance instead of better relief options.
Including their undergraduate borrowing, graduate and professional students have an aggregate limit of $138,500 in direct loans, $65,500 of which can be subsidized. Since 2012, however, graduate and professional students have been eligible only for unsubsidized loans.
There’s a limit on the number of academic years that you can receive direct subsidized loans for those who fall in this category between July 1, 2013, and July 1, 2021. The maximum eligibility period is 150% of the published length of your program. In other words, if you’re enrolling in a four-year degree program, the longest you could receive direct subsidized loans is six years. No such limit applies to direct unsubsidized loans.
There is no limit to the length of time you can receive a Direct Subsidized loan if the first disbursement of your Direct Subsidized loan took place on or after July 1, 2021.
Interest on Subsidized and Unsubsidized Loans
Federal loans are known for having some of the lowest interest rates available, especially compared to private lenders that may charge borrowers a double-digit annual percentage rate (APR):
- For loans disbursed on or after July 1, 2021, and before the July 1, 2022, school year, direct subsidized and unsubsidized loans carry a 3.73% APR for undergraduate students.
- The APR on unsubsidized loans for graduate and professional students is 5.28%. And unlike some private student loans, those rates are fixed, meaning they don’t change over the life of the loan.
There's also one other thing to note about the interest. While the federal government pays the interest on direct subsidized loans for the first six months after you leave school and during deferment periods, you’re responsible for the interest if you defer an unsubsidized loan or if you put either type of loan into forbearance.
Income-driven repayment plans can mean lower monthly payments, but you might still be making them 25 years from now.
Repaying Subsidized and Unsubsidized Loans
You'll have several options available when it comes time to start repaying your loans. Unless you ask your lender for a different option, you’ll automatically be enrolled in the Standard Repayment Plan. This plan sets your repayment term at up to 10 years, with equal payments each month.
Graduated Repayment Plan
The Graduated Repayment Plan, by comparison, starts your payments off lower, then raises them incrementally. This plan also has a term of up to 10 years, but you’ll pay more than you would with the Standard option because of how payments are structured. There are also several income-driven repayment plans for students who need flexibility in how much they pay each month.
Income-based repayment sets your payments at 10% to 15% of your monthly discretionary income and allows you to stretch repayment out for 20 or 25 years. The advantage of income-driven plans is that they can lower your monthly payment. But the longer it takes you to pay off the loans, the more you will pay in total interest. And if your plan allows some of your loan balance to be forgiven, you may have to report that as taxable income.
The upside is that paid student loan interest is tax-deductible. As of 2021, you can deduct up to $2,500 in interest paid on a qualified student loan, and you don't have to itemize to get this deduction.
Deductions reduce your taxable income for the year, which may lower your tax bill or add to the size of your refund. If you paid $600 or more in student loan interest for the year, you’d receive Form 1098-E from your loan servicer to use for tax filing.
Interest on subsidized loans is paid by the government up to six months after you graduate
Subsidized loans have lower interest rates than unsubsidized loans
Unsubsidized loans can be used for graduate school
You don't need to demonstrate financial need for an unsubsidized loan
Subsidized loans can only be used for undergraduate studies
You must demonstrate a financial need for a subsidized loan
The government does not pay any interest accrued on an unsubsidized loan
Unsubsidized loans have a higher interest rate than subsidized ones
What Is the Difference Between Federal Direct Subsidized and Unsubsidized Loans?
Both types of loans are offered by the federal government and must be paid back with interest. However, the government will make some of the interest payments on subsidized loans.
Are Unsubsidized Loans Bad?
Unsubsidized loans have many benefits. They can be used for undergraduate and graduate school, and students do not need to show financial need to qualify. Keep in mind that the interest begins accruing as soon as you take out the loan, but you don't have to pay the loans back until after you graduate, and there are no credit checks when you apply, unlike private loans.
Are Subsidized Loans Better Than Unsubsidized Ones?
Subsidized loans offer many benefits if you qualify for them. While these loans are not necessarily better than unsubsidized ones, they do offer borrowers a lower interest rate than their unsubsidized counterparts. The government pays the interest on them while a student is in school and during the six-month grace period after graduation. However, subsidized loans are only available to undergraduate students who demonstrate financial need.
How Do You Pay Back Subsidized Loans?
You can pay back your subsidized loan at any time. Most students begin paying their loans back after they graduate, and the loan payment is required six months after graduation. This six-month period is known as the grace period, during which time the government pays the interest due on the loans.
When your loan enters the repayment phase, your loan servicer will place you on the Standard Repayment Plan, but you can request a different payment plan at any time. Borrowers can make their loan payments online via their loan servicer's website in most cases.
The Bottom Line
Both direct subsidized and unsubsidized loans can help pay for college. Just remember that either type of loan eventually must be repaid and with interest. So think carefully about how much you’ll need to borrow and which repayment option is likely to work best for your budget.