Subsidized vs. Unsubsidized Student Loans: What to Borrow?

Disclaimer: This article is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other financial professional to determine what may be best for your individual needs.

A college education in the U.S. might be expensive, but it’s still accessible to many American students thanks to federal student loans. The only problem: It can be tough to know which student loans to choose from, mainly subsidized vs. unsubsidized student loans.

If you’re unsure what to borrow or the difference between these student loan types, you’ve come to the right place. Read on for more information about subsidized and unsubsidized student loans.

What are subsidized student loans?

A subsidized student loan, also called a direct subsidized loan, is a federal student loan available to undergraduate students if they show sufficient financial need.

Being subsidized means interest rates are temporarily paid for or halted 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 US Department of Education pays all of the interest on subsidized student loans so long as the borrower is enrolled at least half-time in school. This arrangement continues for six months after graduation and during other applicable deferment periods.

What are unsubsidized student loans?

An unsubsidized student loan is also a kind of federal student loan. But unlike subsidized loans, the interest rates for unsubsidized loans begin accruing as soon as money is distributed to a borrower’s school.

However, this doesn’t mean that students need to pay the interest right off the bat. Students can choose not to pay the interest while in school and throughout a six-month grace period after graduation. However, unpaid interest accumulates during this time and constantly adds to the borrower’s total balance.

Main differences between subsidized and unsubsidized student loans

To recap: Subsidized student loans’ interest is paid for by the government while students are in school and for six months after graduation.

The government does not pay for unsubsidized student loans’ interest at any point, so it consistently accumulates. Graduate students only have eligibility for unsubsidized loans, and only in some cases.

However, there are many differences between subsidized and unsubsidized student loans aside from the above basic breakdown. Here’s a closer look at those differences.

Loan limits and qualifications

Direct subsidized student loans have lower annual loan limits than direct unsubsidized loans. For example, first-year dependent undergraduate students can borrow $3500 in subsidized loans and $5500 in unsubsidized loans. Both contribute to a total federal student loan limit of $23,000.

Furthermore, students must demonstrate sufficient financial need to qualify for subsidized types of loans. You can apply via the FAFSA or Free Application for Federal Student Aid. In contrast, unsubsidized student loans are available to any student borrower, no matter their financial need.

Interest and fees

As mentioned above, the most significant difference between subsidized and unsubsidized student loans is how interest is handled. Subsidized student loans have their interest paid by the government for a while, but unsubsidized loans do not.

There are other differences as well, however. 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 timeframe as subsidized loans.

Meanwhile, subsidized and unsubsidized loans have fees of 1.057% for all loans disbursed between October 1, 2020, and October 1, 2021.

Grace periods and deferment

Subsidized and unsubsidized federal student loans have six-month grace periods, or periods of deferment, meaning student loan repayment won’t begin until six months after graduation.

However, unsubsidized loans’ interest capitalizes, meaning that it is added to the original loan amount. That’s because, as stated above, the federal government doesn’t pay the interest fees for unsubsidized student loans.

Unfortunately, this can lead to a spiraling and costly effect. The larger the principal loan balance gets, for example, the more each successive interest charge adds to the pile. Therefore, prospective students should be careful about using too many unsubsidized federal student loans.

As far as deferment is concerned, the Education Department pays interest for all subsidized loans during deferment periods, like the recent one for Covid-19. Unsubsidized loans, of course, have their interest continue to be collected during deferment.

Recently, the U.S. government released a student loan debt relief program. U.S. citizens could qualify for loan forgiveness. However, this program is currently blocked.

How much money can you borrow?

Now that you know the significant differences between subsidized and unsubsidized student loans, you might wonder what the maximum amount you can borrow is.

Dependent first-year undergraduate 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, only up to $3,500 can be in subsidized loans.

The loan rates increase for each successive year of schooling. Here’s a breakdown:

• Dependent second-year undergraduate students: $4,500 in subsidized loans, $6,500 total.
• Independent second-year undergraduate students: $4,500 in subsidized loans, $10,500 total.
• Dependent third-year and beyond undergraduate students: $5,500 in subsidized loans, $7,500 total.
• Independent third-year and beyond undergraduate students: $5,500 in subsidized loans, $12,500 total.

As you can see, you can only take out a certain amount of money in loans per year from the federal government. If you have more financial needs, you’ll have to seek financial aid through scholarships, grants or loans from private lenders or other institutions.

Which should you use: subsidized or unsubsidized student loans?

Given all this information, you might ask yourself whether you should prioritize subsidized unsubsidized student loans.

For most American students, the answer is clear: Subsidized student loans are superior because you don’t have to worry about interest accruing while you are at school and through any grace or deferment periods.

In this way, you’ll pay less for subsidized loans over their lifespans 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 you can. Take out as much money through this system as possible, as it is the most cost-effective way to pay for your education and benefit from plentiful repayment options.
• Then, only if you still need a little more money, take out extra unsubsidized federal student loans for the remainder of the academic year to pay for the cost of attendance.
• Alternatively, pursue other means of financial aid, like scholarships, grants, and other loans with low-interest rates from secondary financial institutions and lenders like banks or credit unions.

If you do this, you’ll negate as many of your future interest payments as possible and walk away with as much financial aid as possible.

Related: Don’t Be a Victim: 4 Ways You Can Take Charge of Your Student Loans

Should you take out federal or private student loans?

Given the potentially high costs of unsubsidized federal student loans, some students might wonder whether private loans are better.

It’s almost always better to borrow federally first. Why? Private loans, even those offered by trustworthy financial institutions, usually have higher interest rates. They also usually require cosigners if student borrowers don’t have credit histories, which is very common for first-time college 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 extra flexibility compared to private loans.

In the worst-case scenario, if you default on your loans and have a ton of student debt, you’ll have an easier time resolving things with federal student loans than with private student loans.

You should only use private student loans if you have to fill unexpected payment gaps to meet college expenses or if you find an excellent deal with a low-interest rate. In that case, a private student loan might be slightly better compared to an unsubsidized student loan, but that’s rarer than not.

Summary

In many ways, subsidized student loans might be superior to unsubsidized loans. Still, both could allow you to acquire a college education and open up new professional pathways 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. Additionally, consult your college’s financial aid office to receive more personalized counseling.

Looking for more resources to expand your financial knowledge? Explore Entrepreneur’s Money & Finance articles here