You finally have your financial aid award letters…but wait! Why are there two types of federal student loans listed?
Apparently, you’re eligible to receive subsidized student loans and unsubsidized student loans from the federal government through the Direct Loan program.
If you’re wondering, should I borrow subsidized or unsubsidized student loans, the answer is this: prioritize subsidized, but you may still need unsubsidized student loans too.
Keep reading for a full breakdown of why subsidized student loans are better, but why unsubsidized student loans may still be necessary.
What’s the difference between unsubsidized and subsidized student loans?
Both loans have identical interest rates. Both are eligible for the same borrower protections and the same repayment plans. So, what makes them different? It all comes down to who’s paying the interest from the time the loan disburses until the time repayment starts.
Here’s a phrase that really breaks the difference down: Unfortunately, un-subsidized loans cost you more money.
What is a subsidized loan?
A subsidized loan is part of the Federal Direct student loan program and is called a Direct Subsidized Loan. With this type, the government pays the interest while you’re in school at least half-time and during your six-month grace period. They also make interest payments during deferment periods.
As soon as your repayment term begins, the government stops paying. The starting loan amount for your repayment term will equal the original loan amount plus any interest that has accrued from the time your grace period ended to the time you made your first payment.
Not everyone will have the choice to borrow subsidized loans from the government, though. Only students expressing financial need on the Free Application For Student Aid (FAFSA) can borrow subsidized federal student loans. If that’s you, you’ll see Federal Direct Subsidized Loans printed on your FAFSA along with a borrowing limit.
What is an unsubsidized loan?
The federal government also provides students with Direct Unsubsidized Loans. With unsubsidized loans, the borrower is responsible for the interest that accrues upon disbursal. You don’t get any help with interest payments; you must pay back the entire amount you borrow plus interest.
During the four or so years that you’re in college, an unsubsidized loan can accrue a substantial amount of interest. When compounded, this can add thousands of dollars to the total cost of your loan. Be smart with unsubsidized loans and at least make interest-only payments while you’re in school.
Subsidized Federal Student Loans are Better
By now, it should be clear that subsidized federal student loans are the better choice. If you must borrow for college, borrow subsidized federal student loans first.
Compared to unsubsidized federal student loans, with subsidized loans, you:
End up owing less after graduation
The federal government pays the interest on your subsidized loans while you’re in college, so the loan balance you enter college with is the same loan balance you leave college with. That’s not the case with unsubsidized student loans.
If you borrow $2,000 in unsubsidized student loans each year at a 2.75% interest rate, your total loan balance will be about $577.50 higher by the time repayment starts. The interest then gets capitalized, meaning the interest accrues interest.
Even if you initially borrowed the same amount in subsidized and unsubsidized student loans, after capitalization, the monthly payment for your subsidized loans will be higher over the life of the loan.
Receive added perks during deferment
Subsidized student loans also qualify for an interest rate waiver during periods of temporary deferment. You won’t owe monthly payments, and interest won’t accrue because the government will pay the interest for you. The loan balance you entered deferment with is the same loan balance you leave deferment with. Unsubsidized loans do accrue interest during deferment, so deferring unsubsidized student loans can end up being quite costly.
Unsubsidized Federal Student Loans Still Serve Purpose
If you have to borrow student loans, subsidized federal student loans are the best deal. Unfortunately, they don’t always cover your total cost of college. That’s where unsubsidized federal student loans come in.
While they aren’t better than subsidized loans, they are almost always a better choice than private student loans. And they’re most definitely a better choice than Parent PLUS loans.
No cosigner required
Dependent and independent students can borrow unsubsidized federal student loans without a cosigner. Many private lenders require cosigners for private student loans. Parent PLUS loans require a willing parent borrower.
Rates aren’t competitive
If you’re just graduating high school, you might not even have a credit score. Luckily, with unsubsidized federal loans, rates aren’t based on your credit score or income. They’re the same for all borrowers and are set by Congress. Plus, that rate is always much lower than the Parent PLUS interest rate.
No payments until after the grace period
Repayment for Parent PLUS loans and some private student loans starts immediately following disbursement. With unsubsidized student loans, repayment doesn’t begin until 6 months after you drop below half-time, graduate, or withdraw.
Eligible for borrower protections
Aside from the interest waiver during college, subsidized and unsubsidized Direct loans are eligible for the same federal borrower protections. This includes income-driven repayment plans, academic or economic hardship deferment, and death and disability discharge. Private lenders may offer some protection, but they won’t be as generous as the federal student loan benefits.
Qualify for federal student loan forgiveness programs
You can even have your unsubsidized federal student loans forgiven. Borrowers working in the public sector for the government or an eligible non-profit can qualify for Public Service Loan Forgiveness (PSLF) after 10 years of eligible payments. Other borrowers can qualify for forgiveness after 20 to 25 years on an income-driven repayment plan.
Final Thoughts on Which is Better: Subsidized or Unsubsidized Student Loans?
If you can avoid borrowing student loans for college, do it. If you must borrow, max out on your subsidized federal student loans before turning to any alternatives. They’re the cheapest option available to families because the government pays the interest while you’re in school or in a period of deferment.
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