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Subsidized vs. unsubsidized student loans: Which is best for you?

Don't let confusion over your loan options kill the excitement of college.

Justin Cupler

Contributing Writer at Tally

May 6, 2020

As if going to college isn't hard enough with the pressures of leaving home for the first time, taking on substantial class loads and socializing with all-new people, throwing in financial aid options may make your head start spinning. Especially confusing for first-time college students is weighing subsidized vs. unsubsidized student loans. 

To ease the process, we explore the differences between these two loans, the benefits and drawbacks of each and which you should pay off first. Let's start with an in-depth look at what each loan type is. 

Subsidized vs. unsubsidized student loans

There are two key types of federal student loans: direct subsidized loans and direct unsubsidized loans

After you fill out your Free Application for Federal Student Aid (FAFSA), your college will determine your financial need, which it bases on you and your parents' income and assets. Your  financial need determines the federal student loans available to you. 

Here's a general look at subsidized and unsubsidized loans. 

Direct subsidized loans

The direct subsidized loan is the most favorable type of student loan, as it offers better terms while you're in college.

A direct subsidized loan's key benefit is that the U.S. Department of Education pays the interest on the direct loan while you're enrolled in school at least half-time. After leaving school, there's a six-month grace period, known as a deferment, where the Department of Education continues paying the interest.

Keep in mind, you only qualify for direct subsidized loans for a limited time, as the Department of Education restricts them to 150% of your program's published time frame. For example, if you are in a four-year bachelor's degree program, you only qualify for direct subsidized loans for six years. After that, you must move to direct unsubsidized loans. 

Also, only undergraduate students with a school-determined financial need qualify for subsidized loans.

Direct unsubsidized loans

Direct unsubsidized loans are like subsidized loans in that they are federally backed, but they have a distinct difference when it comes to interest payments.

Unlike the direct subsidized loans, unsubsidized loans require you to pay the interest on the loan while you attend school. You can choose not to pay the interest, but your lender will capitalize the unpaid interest and apply it to your loan after you leave school. 

For example, if you have $2,000 in unpaid interest after graduating school, your lender will add that amount to your loan. 

While its interest terms may not be in your favor, there are a few benefits to unsubsidized loans. One benefit is that they are available to virtually all college students, including graduate students and those who will require more than 150% of their program's published time frame to graduate. They also don't limit the amount you can borrow by your household income. 

Let's now look into other differences and similarities between subsidized and unsubsidized student loans.

Subsidized vs. unsubsidized student loans: loan limits 

Borrowing limits vary between direct subsidized loans and unsubsidized loans, but they work together to create aggregate loan limits.

If you’re a first-year student who is still a dependent (parents claim you on their taxes), the total annual loan limit is $5,500, but only $3,500 of that may come from a direct subsidized loan. The remaining $2,000 must come from an unsubsidized loan.

As a second-year dependent student, your total annual loan limit rises to $6,500, and no more than $4,500 of that can come from a direct subsidized loan.

From your third year on, the total annual loan limit is $7,500, but only $5,500 can come from a direct subsidized loan. The remaining $2,000 must come from an unsubsidized loan.

As a dependent undergraduate student, the aggregate loan limit for your entire time in college is $31,000. Only $23,000 of that can be from subsidized loans, and the remaining $8,000 must come from unsubsidized student loans. 

If you're an independent student, meaning no one can claim you as a dependent on their taxes, the total annual loan limits (subsidized and unsubsidized combined) climb to $9,500 in your first year, $10,500 in your second year and $12,500 in your third year and beyond. 

While the total loan limits increase for independent students, the subsidized loan limits remain the same as for dependent students. The increases are all on the unsubsidized side.

Independent students can borrow a total of $57,500 throughout their undergraduate years, but only $23,000 of that can be from subsidized loans.

All graduate students are eligible for up to $20,500 per year in unsubsidized loans only.

Including all undergraduate loans, the aggregate loan limit for graduate students is $138,500. Only $65,500 can come from direct subsidized loans, which includes the subsidized loans graduate and professional students were eligible for prior to July 1, 2012.

If your college tuition exceeds the total borrowing limits of $57,500 for undergraduates and $138,500 for graduates, you must find alternative funding, such as a Direct PLUS Loan or private student loan.

Subsidized vs. unsubsidized student loans: interest rates

Because subsidizing something is all about keeping costs down, it's easy to assume direct subsidized loans will have a better interest rate. This assumption is inaccurate. 

Other than the government footing the interest bill while you're in school and during your six-month grace period after leaving school, direct subsidized loans and direct unsubsidized loans have identical, fixed interest rates.

As of the last interest rate shift, which covers students who take financial aid between July 1, 2019 and July 1, 2020, both loan types have a 4.53% rate for undergraduate students and a 6.08% rate for graduate and professional students. Your credit score and credit history have no impact on these interest rates.

With a direct subsidized loan, the Department of Education covers your interest payments while in school and for the six-month deferral after leaving school. This interest deferment adds up to some hefty savings when compared to an unsubsidized federal loan. 

For example, if you took the maximum direct subsidized loans for a four-year undergraduate degree, you would save roughly $3,000 in interest charges while in school.

Subsidized vs. unsubsidized student loans: repayment plans

When you graduate from college, there are generally two things top of mind. First, finding a job. Second, how are you going to repay all that student loan debt?

If you have unsubsidized student loans, you might fear you don't have all the same repayment options afforded to direct subsidized loans.

Fortunately, the federal government offers the same repayment options for both of these two direct loan programs. It even offers the same student loan forgiveness plans, including those for teachers. The most common repayment plans for federal direct loans include: 

  • Standard plan: A 10-year repayment term with fixed monthly payments.

  • Graduated plan: You have lower monthly payments initially that gradually increase every two years until you pay off the loan in 10 years.

  • Extended plan: You get a 25-year repayment term with fixed or graduated payments.

  • Revised pay as you earn: Payments are 10% of your discretionary income, and your remaining loan balance is forgiven after 20 years of payments on undergraduate loans and 25 years on graduate loans.

  • Pay as you earn: Payments are 10% of your discretionary income but never exceed the standard plan's payment. After 20 years, your student loan debt is forgiven. 

  • Income-based repayment plan: Payments are 10-15% of your discretionary income, and your student loan debt is forgiven after 20-25 years, depending on the loan-disbursement date.

  • Income-contingent repayment plan: Payments are the lesser of 20% of your discretionary income or a fixed 12-year repayment plan. The federal government forgives your student loan debt after 25 years if not paid in full.

  • Income-sensitive repayment plan: Payments are based solely on your annual income, and your loan balance is forgiven if not repaid in 15 years.    

Subsidized vs. unsubsidized student loans: loan fees

In both types of loans, there are fees charged at disbursement. These loan fees are a small percentage, which the federal government deducts from the loan disbursement so you don't pay this fee out of pocket. 

At the time of this writing, the fees were the same for subsidized and unsubsidized loans. Those disbursed between Oct. 1, 2019, and Oct. 1, 2020, carry a 1.059% loan fee.

For example, if you took out a $5,000 federal student loan for the school year, the federal government would pinch $52.95 from the disbursement to cover the fees. 

Prioritizing student loan repayments

Because they share the same interest rate and have the same fees, it may seem like it doesn't matter whether you pay off your direct subsidized loans or your unsubsidized loans first. However, if you look closely at your loan terms, you'll find savings by prioritizing payments.

First, because student loan interest rates vary by year, you'll want to organize them by interest rate from high to low. From there, pay the loan with the highest interest rate first. If two loans have the same interest rate, pay the one with the highest balance first.  

Alternatively, you can skip the whole calculation and simplify the process by applying for a federal Stafford loan consolidation. Subsidized and unsubsidized student loans qualify for this consolidation, which rolls all your federal student loans into one loan with a fixed interest rate. 

If a student loan consolidation is right for you, you can choose from any of the repayment plans mentioned above, even the debt-forgiveness plans. 

Subsidized student loan pros and cons

While a subsidized loan may seem like a no-brainer with its deferred interest while you're in school, it's not all rosy. Here are the pros and cons to consider when looking into subsidized loans.

Direct subsidized loan pros

  • No interest charges while in school

  • Six-month, interest-free grace period after leaving school

Direct subsidized loan cons

  • You must demonstrate a financial need

  • Graduate and professional students don't qualify

  • Your parents' income can impact your eligibility

  • There is a time limitation on eligibility

Unsubsidized student loan pros and cons

With accruing interest while you're in school, unsubsidized student loans may seem far less favorable to the average college student. But just like how subsidized loans aren't perfect, unsubsidized loans offer plenty of benefits too. Here are the pros and cons. 

Direct unsubsidized loan pros

  • No time limitation to complete your degree

  • Allows you to extend the subsidized loan cap

  • No need to prove a financial need

  • Graduates and professional students qualify

Direct unsubsidized loan cons

  • Interest charges accrue while you're in college

Prioritize direct subsidized loans

Because you can save big money on interest while attending school, it's best to prioritize subsidized loans if you qualify.

After filling out your FAFSA, you will understand what grants and subsidized loans you qualify for based on your financial need. Use those loans and grants first, then meet the remaining cost of attendance, like leftover tuition, course fees, books and room and board, with unsubsidized loans if needed. 

If you hit the annual cap on direct student loans, you can look to private student loans. These can come with higher interest rates and fewer repayment options, so these should always be a last resort.

Hit the books

The key difference between direct subsidized and direct unsubsidized loans is how interest is handled while you’re in school. Because subsidized loans offer waived interest charges while you’re attending school, you’ll want to use these first, but you’ll likely end up mixing in unsubsidized loans to fill the gaps. 

When it comes time to pay off those loans, there’s no need for complex calculations to figure out which loan to prioritize. Simply roll them all into a federal Stafford loan consolidation and pay them off at the same time.  

With the muddy waters of student loans cleared up, it's time to hit the books.