Subsidized vs Unsubsidized Student Loans: Which Loan Is Better?

Last Updated on February 1, 2022 by pf team

Choosing between subsidized vs unsubsidized student loans can be a complex topic and the type of loans you have can have a long-term financial impact. Here’s what you’ll need to know before you sign the dotted line.

subsidized vs unsubsidized student loans
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What is the difference between subsidized and unsubsidized student loans?

If you’re beginning to research ways to finance your education, you’ve probably encountered the terms subsidized loans and unsubsidized loans.

These loans are similar in most ways: both have an origination fee, both have a fixed interest rate, and both have a grace period before you have to start repaying the loan.

However, one key difference is that interest on a subsidized loan the federal government pays the interest while you are in school and during a 6-month grace period following graduation.

The savings can be significant with a subsidized loan. Another key difference is that the borrowing limits are lower.

This leads to a common situation in which many students have both subsidized and unsubsidized student loans.

What is a direct subsidized student loan?

A direct subsidized loan, also called a subsidized stafford loan, is a type of student loan available for undergraduates through the US Department of Education that has cost advantages over other types of student loans.

The subsidy refers to a unique cost-saving benefit: The US Department of Education pays the interest expense while you are in school at least part time — as determined by the school itself — and during a 6-month grace period following graduation.

Interest accrued while loans are in deferment, which is a temporary loan suspension, are also paid by the government for subsidized loan balances.

How do I qualify for a subsidized student loan?

Eligibility for subsidized loans is based on financial need.

The Free Application for Federal Student Aid (FAFSA) is the starting point for both subsidized and unsubsidized loans and the information you provide on your application helps your school’s financial aid office assemble a financial aid package customized for you.

Your financial aid offer will include details on the expected cost of attendance (COA) for that school, as well as grants, scholarships, work-study programs, and federal loans.

Another important factor determines your financial need and whether you qualify for a subsidized loan: The amount of money your family (including you) is expected to pay toward your student expenses is called the Expected Family Contribution (EFC) and can affect the amount of aid for which you qualify.

The EFC considers both your financial strength and the financial strength of your parents when determining an EFC amount.

The EFC formula is available online through the Federal Student Aid website, although it can change each year.

The financial aid offer depends on several calculations, which makes the offer unique to each applicant. Generally, lower income leads to a lower EFC, which can help you qualify for a subsidized loan.

However, there are cases where choosing a school with a higher COA can create a higher calculated financial need even with a higher EFC considered.

It’s important to note that subsidized loans are only available for undergraduates and that you’ll need to meet Satisfactory Academic Progress (SAP) requirements, meaning you’ll need reasonably good grades to keep your subsidy.

How much can I borrow with subsidized loans?

The amount you can borrow varies based on which year of your undergraduate studies you are in and the amounts apply to the borrowing limit for that year alone. There is no carryover if you borrow less than your limit in earlier years.

  • First year students can borrow up to $3,500
  • Second year students can borrow up to $4,500
  • Third year and later students can borrow up to $5,500 per year

Graduate students are not eligible for subsidized loans. It’s also useful to know that grade levels are determined by the number of credit hours passed as opposed to the number of years you’ve been in school, although the grade levels usually coincide with the number of years in school.

In total, the aggregate loan limit for subsidized loans is $23,000. It isn’t uncommon for students to have both subsidized and unsubsidized loans, which raises the total borrowing limit.

However, the aggregate limit for subsidized loans remains unchanged at $23,000 even if you have both types of loans.

What are the fees for a subsidized loan?

Subsidized loans are subject to the same origination fees as unsubsidized loans, currently 1.059%. Origination fees can change from year to year and are deducted from the disbursement.

For example, a first year student who borrows $3,500 with a subsidized loan would receive a disbursement $3,462.93 after the origination fee of 1.059% is deducted.

Interest accrues on the full $3,500 borrowed even though less than that amount can be used to pay for school expenses.

How does interest accrue for my subsidized student loan?

With a subsidized loan, interest accrues daily beginning on your disbursement date but is paid by the US Department of Education while you are in school and for a 6-month grace period following graduation.

Under some repayment plans, like an income-driven repayment plan, the government may also pay all or a portion of your interest on subsidized loans.

While interest accrues daily, it doesn’t compound daily. In fact, the formula used to calculate your daily interest is fairly simple. Just divide the interest rate by the number of days in a year (365) and multiply by the loan balance.

If you borrowed $3,000 at the current interest rate of 4.53%, the daily interest is 37 cents per day.

However, with a subsidized loan, the government pays the interest for you while you are in school and in a few other situations.

Federal student loans feature a grace period which allows you to postpone repayment until 6 months after graduation.

Accrued interest during the grace period is subsidized. Accrued interest during approved deferment, which allows you to stop making payments temporarily, is also paid by the federal government.

When do I start paying back my direct subsidized student loan?

Generally, you don’t have to start paying back a subsidized loan until 6 months after graduation. However, loan repayment may be required to start earlier if you drop out of school.

If you are a military member, you may have the option of beginning payments at a later date. Other types of deferment or forbearance may be available as well based on your eligibility.

What is a direct unsubsidized student loan?

A direct unsubsidized student loan is a loan provided through the federal government at a fixed interest rate on which the borrower is responsible for all accrued interest.

Unlike a subsidized loan, the US Department of Education does not pay the accrued interest on unsubsidized loans while you are in school or during the 6-month grace period following graduation.

Interest accrued during deferment or forbearance is also paid by the borrower when loan repayment resumes.

How do I qualify for an unsubsidized student loan?

Applying for an unsubsidized loan follows the same steps as required for a subsidized loan, with the first step being the Free Application for Federal Student Aid (FAFSA), which you can complete online or even on your mobile device.

The FAFSA includes questions about your finances and your family finances, including incomes, and is used to determine how much you can afford to pay toward your college education.

Your FAFSA is also used to determine eligibility for certain grants, like Pell Grants, which can be used for your school costs but do not have to be repaid.

The amount of student aid you qualify for is spelled out in a letter from the school or schools to which you’ve applied.

This letter or package is called a financial aid offer. Grants and scholarships that you qualify for will be listed in the package as well as loan offers to help cover the amount that isn’t covered by grants, scholarships, or your family’s contribution.

To remain qualified for ongoing federal financial aid, you'll need to stay in school at least half-time and meet minimum academic performance requirements as determined by your school.

How much can I borrow with unsubsidized student loans?

Borrowing limits are higher for unsubsidized loans than for subsidized loans but still vary according to which year of your studies you're in currently.

The amount you can borrow is also affected by whether you are a dependent or independent for tax purposes, with students who are independent eligible for higher borrowing limits.

The table below gives an overview of borrowing limits for unsubsidized loans. If you have any subsidized loans, the amount available for unsubsidized loans may be reduced. In total, dependent students can borrow no more than $31,000 in combined subsidized and unsubsidized loans.

Independent undergraduate students may qualify for up to $57,500 in combined subsidized and unsubsidized loans.

First year$ 5,500$ 9,000
Second year$ 6,500$ 10,500
Third year
and after (undergraduate)
$ 7,500$ 12,500
Graduate or Professional
$ 20,500
(graduate students
are considered independent
$ 20,500

Graduate and professional students can qualify for up to $138,500 in combined Subsidized and unsubsidized loans with the aggregate limit including loans received during undergraduate years.

Higher borrowing limits may be available if your parents are ineligible for a Direct PLUS Loan.

What are the fees for an unsubsidized student loan?

Direct unsubsidized student loans have an origination fee of 1.059%. This amount is deducted from the loan disbursement amount, reducing the amount you’ll have available to pay student expenses.

The origination fee percentage is the same for both subsidized and unsubsidized student loans.

How does interest accrue for my unsubsidized loan?

In addition to borrowing limits, one key difference for unsubsidized loans when compared to subsidized loans is that the interest on unsubsidized loans is not paid by the US Department of Education.

The borrower is responsible for interest accrued while in school and during the 6-month grace period after graduation or during most periods of deferment or forbearance.

Interest charges are based on disbursement amounts, which usually coincide with the school year. For undergraduate students the current interest rate for direct unsubsidized loans is 4.53%.

The interest rate for graduate or professional students is 6.08%. However, graduate students will likely have a combination of undergraduate and graduate loans, with two or more interest rates.

Here’s an example of how the interest accrual might look for an undergraduate student:

at 4.53%
of years
to accrue
$ 3000$ 135.904$ 543.60
$ 3000$ 135.903$ 407.70
$ 3000$ 135.902$ 271.80
$ 3000$ 135.901$ 135.90
Total$ 12000$ 1,359.00

In this example, $12,000 borrowed over a course of four years results in $1,359 in interest that has accrued while in school.

There's no requirement to pay this interest while still in school but paying interest as it accrues can save on additional interest expenses later.

Let's say you graduated without paying any interest that has accrued on unsubsidized loans.

At the end of your 6-month grace period following graduation, the unpaid interest will be added to the loan balance and will become subject to interest itself.

With unsubsidized loans, the interest that accrues during the grace period can also be added to the loan balance. For unsubsidized loans, interest also accrues during deferment or forbearance periods.

When do I start paying back my direct unsubsidized student loan?

The repayment requirements for unsubsidized student loans are similar to those for subsidized student loans and in most cases repayment is required to begin after the 6-month grace period following your graduation.

However, it's wise to pay the interest charges as they accrue to prevent  the interest from being added to your loan balance in a process called capitalization.

By paying the interest as you go,  you can potentially save hundreds of dollars in interest charges later — or perhaps even thousands of dollars — depending on the amount, interest rate, and repayment terms for your loans.

Don't overlook private students loan lenders

Most students can qualify for federal student loans but there are some cases in which students may become ineligible and other cases in which the amount of student aid available is insufficient to cover school expenses.

The latter is more common with more expensive schools. Private student loans are a viable option to help cover the shortfall, but private student loans require a credit check and proof of Income.

As a result, private student loans often require a cosigner, like a parent or guardian.

Repayment terms for private loans can take several forms, including repayment beginning 6 months after graduation. However, private student loans are always unsubsidized and interest begins to accrue at disbursement.

Should I pay subsidized or unsubsidized loans first?

If you're still in school and have both subsidized and unsubsidized loans, one of the best ways you can invest a few extra dollars is by paying the interest on your unsubsidized student loans. 

This prevents the interest amount you’ve paid from being added to your loan balance.

If you've graduated and aren't eligible for any grace periods or deferment, there isn't any real advantage to paying down unsubsidized loans over subsidized loans, assuming the interest rates are the same.

You might instead choose to pay down loans with the largest balances or loans with higher interest rates if there’s a significant difference.

However, if you have private student loans, it can make sense to pay down these loans first because interest rates may be higher (or variable) and repayment terms can be less liberal than with federal direct loans.

Do subsidized and unsubsidized loans affect your credit?

Federal direct subsidized and unsubsidized loans can affect your credit score — but the primary risk is when you have late payments — or a default.

If your federal student loans are in good standing and are paid on time, having the loan will help you build a credit history by demonstrating responsible use of credit.

Choosing a deferment or forbearance does not negatively affect your credit score and can be viable options to help avoid damage to your credit if you qualify and are struggling while you're building your income.

It’s also very difficult —  if not impossible —  to discharge student loan debt in a bankruptcy. This makes student loan repayments a priority even if you have other debt at a higher interest rate.

Subsidized vs unsubsidized student loans: which is better?

If you qualify for a subsidized loan, the interest savings can be significant, particularly on larger loan balances. However, not everyone can qualify for subsidized loans because eligibility is based on financial need.

Unsubsidized loans are available to nearly everyone and if managed well can be almost as affordable as a subsidized loan. The key to keeping loan balances from growing due to interest charges is to make interest payments as you go whenever possible.

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