Subsidized vs Unsubsidized Loans

College is a huge expense – too big for most people to afford without help. Fortunately, the federal government has student loan programs that allow you to pay that cost over time. They can be broken down into two types – subsidized vs unsubsidized loans.

This article will help you understand the difference between subsidized and unsubsidized loans so you can make the most cost-effective decisions about them.

Topics covered include:

• Federal student loans - background

• What is the difference between subsidized vs. unsubsidized loans?

• Which are better: subsidized or unsubsidized student loans?

• Who is eligible for subsidized and unsubsidized student loans?

• What are the borrowing limits on subsidized and unsubsidized student loans?

• What if I need more than the federal student loan limit?

• Does it matter which type of loan I pay back first?

• Subsidized vs. unsubsidized loans: FAQs

Federal student loans are either subsidized or unsubsidized. On the surface, subsidized loans and unsubsidized loans seem very similar. However, there is a crucial difference between the two that could make a difference of thousands of dollars in interest charges over the life of your loan.

There’s a good chance you might end up with both subsidized and unsubsidized loans. In that case, the difference between the two might guide which you want to start paying off first. 

Federal Student Loans Background

Federal student loans are offered by the U.S. Department of Education as a form of financial aid. They are known as Federal Direct Loans because the federal government is the lender.

Because these loans are provided by the government rather than by for-profit lenders, federal student loans offer a variety of advantages. These may include lower interest rates, easier approval standards, and more favorable repayment terms.

Two major categories of Federal student loans are Federal Direct Subsidized loans and direct unsubsidized loans. 

What Is the Difference Between Subsidized vs. Unsubsidized Loans?

“Government subsidized” means that the government pays all or part of your costs. In the case of subsidized loans, The government pays interest charges on your student loan while you are still in school, and for six months after.

With both subsidized and unsubsidized student loans, you don’t have to start repaying until you’ve been out of school for six months. That six months is your grace period. 

With most loans, even when you don’t have to make payments, the loan accrues interest that you eventually have to pay. The difference between subsidized and unsubsidized federal student loans is that with subsidized loans, the government pays your interest while you are still in school and during the grace period. 

Because of that subsidy, you don’t have to come up with money to pay interest while you’re enrolled in school. That interest is also not accruing and increasing your balance when you do start making payments. 

In contrast, interest on an unsubsidized loan starts to accrue from the day your funds are disbursed, and you are responsible for its payment. 

You can choose to wait until your grace period ends before repaying direct unsubsidized loans. However, your balance will increase as the interest owed piles up. The longer you go without paying it, the more it will add to the total you eventually owe. 

Which Are Better: Subsidized or Unsubsidized Student Loans?

Having the government subsidize your loan interest until the end of your grace period is a real advantage of subsidized student loans. 

Those interest payments could total a few thousand dollars by the time you finish school and the grace period expires. That’s free money, and free is always better.

Who Is Eligible for Subsidized and Unsubsidized Loans?

While subsidized loans are more desirable, they are tougher to get than unsubsidized loans. 

Subsidized loans are only available to undergraduate students. And eligibility is based on financial need. “Financial need” is the difference between what your school costs and what you and your family should be able to contribute towards your education. 

Your financial need can be determined by filling out the Free Application for Federal Student Aid form -- commonly referred to as FAFSA. You can find this on the federal government’s FAFSA website. 

Unsubsidized loans are less restricted. They are available to both undergraduate and graduate students. Plus, you don’t have to demonstrate financial need to qualify for an unsubsidized loan.

What Are the Loan Limits on Subsidized and Unsubsidized Loans?

There are two types of loan limits on subsidized and unsubsidized student loans:

• Loan limits are determined in part by the cost of your school. You cannot borrow more than you need to pay for legitimate educational expenses.

• There are also absolute dollar limits on how much you can borrow, both year-by-year and over the total length of your academic career. 

The dollar limits depend on a variety of factors, including what year of school you are in, whether you are someone’s dependent or financially independent, and whether the loan is subsidized or unsubsidized. 

There are several variables and the loan limits are subject to change from year to year. You should go to the Department of Education’s Federal Student Aid website to see how student loan limits would apply to you. 

Just as an example, for the 2022-2023 academic year, a college freshman who was listed as a dependent on someone else’s tax return could borrow a total of $5,500 in federal student loans. However, no more than $3,500 of that could be in subsidized loans. 

For freshmen who are not listed as dependents on someone else’s taxes, the overall limit goes up to $9,500. However, the limit on the subsidized portion would remain at $3,500.

What If I Need More Than the Federal Student Loan Limit?

College costs are often a lot higher than federal student loan limits. However, you have other options for financing your education. 

First, you should explore other forms of financial aid before borrowing any money. You may be eligible for grants and scholarships that don’t have to be paid back. These can substantially reduce the cost of college. 

If you still need to borrow more than the federal student loan limits, you could apply for a loan from a private lender. 

These loans generally have higher ceilings than the federal loan limits. However, they also generally have higher interest rates, unless you or your family have excellent credit and ample financial resources. 

Private student loans often have less favorable repayment terms as federal loans. For example, they may not defer payments until after you leave school. If they do, they certainly won’t pay your interest in the meantime.

Does It Matter Which Type of Loan I Pay Back First?

The difference in loan types affects more than your decision about which type of loan to apply for. It could also guide your repayment plans. 

Since most students get a series of student loans at various times during their college careers, you may end up with loans with different interest rates.

In all cases, you should make each required payment for each loan by its due date. Beyond that though, if you have the means to pay a little extra, start with the loans with the highest interest rates.

The faster you pay down what you owe, the less interest you’ll pay. Paying down the loans with the highest interest rates fastest will save you the most. 

Where the type of loan comes into play is if you can start making payments before your grace period ends. In this case, it makes sense to pay off unsubsidized loans first because that slows the pace at which they accrue interest. 

Once the grace period is up, this would no longer be a factor because all your loans would be accruing interest that you are responsible for paying.