What are the differences between unsubsidized and subsidized loans?

subsidized loan

It doesn’t seem to matter who you are or what you do. A college education will likely require you to take on student loan debt. Just a few years ago, in 2017, 65 percent of all college graduating seniors had nearly $30,000 in student loans.

College expenses can be for books, tuition, room and board, meal plans, and other fees. It can take upwards of $21,000 a year to pay for all of those things, and most students, along with their families, can’t afford that much out of pocket.

Of course, there are financial aid options, including grants and scholarships, but student loans are another thing most students have to consider. To do so, however, they must first complete their FAFSA (Free Application for Federal Student Aid). Still, you may not know that federal student loans come in different varieties. You may be offered multiple loan options with your specific financial aid package based on your financial situation.

The two most common federal student loan options are Direct Unsubsidized Loans and Direct Subsidized Loans. They sound very similar, and there are some similarities. Still, they are profoundly different from each other. The difference between subsidized and unsubsidized loans could translate into more interest payments that are higher (thousands of additional dollars spent over the life of the loan).

It is important to understand how these two types of loans are similar and different. We discuss federal unsubsidized and subsidized student loans, enabling you to make smarter financial decisions. You can apply this information when accepting or rejecting student loans from your financial aid package. In addition, you will also be more aware of which loans should be a priority when it comes to their payment.

A snapshot of subsidized and unsubsidized student loans

Both unsubsidized and subsidized student loans are options available and offered to college students by your federal government. Therefore, the details of each type of loan – including fees, interest rates, eligibility requirements and maximum loan limits – are governed by law.

Yes, there are some similarities, but there is also a significant difference between subsidized and unsubsidized student loans. The biggest difference is how interest on the loan can accrue.

Direct Subsidized Loans are only available to college students, and to qualify, you must demonstrate significant financial need for the loan. The federal government will cover any accrued interest on your principal as well, but only under specific conditions. These include:

  • When you are enrolled in college full or part time
  • When the loan is in deferment
  • During the grace period
  • This is the first six months after you finish school, drop out, or drop out part-time. During this time, you don’t have to make any payments, and your interest is stopped or paid by the federal government.

Because the Department of Education pays any interest that has accrued on the principal during this time, it is subsidizing education.

On the other hand, unsubsidized direct loans will accrue interest, just like any other type of loan. Once the loan is disbursed (you or your school receives the money), the principal begins to accrue interest. It doesn’t matter if you’re currently enrolled in college, if you’re in deferment, or if the loan is in a grace period.

Although there is no interest to pay, since they are added, they continue to be added to the principal or they are capitalized. Therefore, the interest is going to start accumulating on its own, as well as your principal.

See the difference between subsidized and unsubsidized loans in action

It can be a bit difficult to understand the process without doing some numbers. So let’s say there are two borrowers. They are both freshmen in college and are taking out a $3,500 federal student loan. Each loan carries an interest rate of around 4.53%, and both are on the standard ten-year repayment plan. However, Borrower A has a subsidized loan, and Borrower B has an unsubsidized loan.

Borrower A will not have accrued interest while in school, so the balance will not go up. So, after graduation, they only have to pay $36.32 a month. In total, Borrower A will pay $4,358 for the loan, of which $858 will be interest.

Borrower B has a loan that begins to accrue interest during the four years they are in college. It’s about $634. They graduate, but cannot pay the accrued interest. Therefore, it is capitalized and added to the principal amount, bringing the loan balance to $4,134. That means Borrower B is going to make payments of $42.90 each month, paying a total of $5,148. Borrower B paid almost $800 more than Borrower A.

Now, what could happen if both borrowers couldn’t make their payments right away when they graduate? They both have that six-month grace period and could also put the loan in deferment for a full 12 months after that.

If this happens, Borrower A will still have a balance of $3,500 and will pay $4,358 over the life of the loan. However, Borrower B will have a balance that grows to $4,420, for which he will pay $5,504 over the life of the loan. That’s a difference of over $1,000.

How Subsidized Student Loans Work

There are two things to consider for subsidized student loans, including fees and interest.

Subsidized direct loans that are disbursed between July 2019 and July 2020 have an interest rate of only 4.53%. The rate is fixed, so it cannot change during the life of the loan. This interest rate is set by Congress each year.

You learned earlier that interest accrues on the loan when you’re enrolled as a college student going to school at least part-time, during deferment periods, and when you’re in the grace period. If you are in forbearance (the act of temporarily stopping payments for financial reasons) or in active repayment, the amount is accruing interest.

You also have other fees to deal with. Subsidized Direct Loans disbursed between October 2019 and October 2020 will have a loan fee of 1.059%, which is added to the principal.

Who can qualify for a Direct Subsidized Loan?

To qualify for a Direct Subsidized Loan, you must submit your FAFSA application. There are limited amounts of funds available for each school year in subsidized loans. Therefore, only applications that demonstrate specific financial need are eligible for such a loan.

Other requirements include being a college student, attending an eligible college, and being at least part-time. No cosigners are needed, and you don’t have to pass a credit check to get approved.

Maximum Subsidized Loan Amounts

For 2019, through your college career, you can borrow $23,000 in subsidized student loans if you’re eligible. The exact amounts you can receive may vary from year to year. Consider this: In the first year, you may only receive $3,500, but in the second year, you will receive $4,500. Every other year of your college career, you receive $5,500.

How unsubsidized student loans work

Unsubsidized student loans are also disbursed to college students. As of the 2019-2020 school year, they also offer interest rates of 4.53%. Graduate and professional students are also eligible for unsubsidized student loans at interest rates of 6.08%. All rates are fixed, so they won’t change over the life of the loan. Congress also sets loan rates each year, such as subsidized student loans.

However, unlike a subsidized student loan, the unsubsidized loan accrues interest while the loan is in the grace period. Interest also accrues while you are enrolled in classes, as well as during deferment, payment, and forbearance periods. If you cannot pay the accrued interest, it is capitalized and added to the principal of the loan.

Direct Unsubsidized Loan rates are 1.059% through 2019 and 2020.

Who can qualify for a direct unsubsidized loan?

To qualify for Direct Unsubsidized Loans, you must submit your FAFSA application. However, unlike subsidized loans, these loans do not require you to demonstrate financial need to obtain them. They are available to professional, graduate, and undergraduate students, regardless of credit score or history.

Maximum Unsubsidized Loan Amounts

As with a subsidized student loan, there is a maximum amount of debt you can carry from the federal government. The exact amounts depend on the type of degree (professional, graduate or non-graduate), as well as the dependency situation (for non-graduates).

College students and dependents can borrow up to $31,000 throughout their college career in unsubsidized loans. Similarly, if you qualify for the maximum of $23,000 in subsidized loans, you can borrow $8,000 in an unsubsidized loan.

Exact amounts vary. For example, in the first year, you might get $5,500, while in the second year, you might get $6,500. Subsequent years may offer $7,500.

College and independent students can borrow up to $57,500 over their entire college career in unsubsidized loans. This means that if you qualify for $23,000 in subsidized loans, you can borrow up to $34,500 in an unsubsidized loan.

Again, the exact amounts vary. You might get $9,500 the first year and $10,500 the second, with subsequent years bringing you $12,500.

Graduates and professionals can borrow up to $138,500 in unsubsidized loans throughout their entire educational career, which includes undergraduate courses. It is possible to borrow up to $20,500 in unsubsidized loans each year from your professional or graduate status.

Which one is the best?

You may be wondering which option is the most preferable. You have learned the difference between subsidized and unsubsidized loans. Therefore, you can see that a subsidized loan offers many benefits over an unsubsidized one. If you could receive both types of loans, the ideal would be to choose the subsidized loan options first.

However, both unsubsidized and subsidized loans are nicer than private student loans because federally backed loans are going to have a lower interest rate. You’ll also be more protected than you could be with a private lender.

If you have both types of federal student loans, it’s best to make interest-only payments on the unsubsidized loan each month, regardless of whether you’re in a forbearance, deferment, or grace period, or while you’re a student. This helps you avoid compounding interest so the loan balance doesn’t keep growing. You may also want to pay off any unsubsidized loans first, if possible.

By aamritri

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