Understanding Federal Direct Subsidized vs Unsubsidized Student Loans

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Understanding Federal Direct Subsidized vs Unsubsidized Student Loans

As you look at how your family will afford to send your children to college, loans of some sort may be a consideration. Loans are available for students as well as parents, and can be a significant help in paying for school.

 

Student loans can come from the government or private lenders. Some loans from the government are subsidized, depending on your family’s financial need. It’s vital to understand the different types of loans and what the difference between subsidized and unsubsidized student loans.

 

What Is A Subsidized Student Loan?

A subsidized loan is only available to undergrads through the federal Direct Loan program. They are called “subsidized” because interest is paid by the government while the student is in school.

 

The interest rates are fixed for the life of the loan, and are set by the government. A student does not need to demonstrate a specific income or credit score to qualify. Instead, students fill out the FAFSA to apply for these loans. Eligibility is based on financial need.

 

The government covers the interest on subsidized loans as long as the student is enrolled at least half-time, and during periods of deferment or forbearance after graduation. Finally, no payments are due on subsidized loans until six months after graduation.

 

Unfortunately, graduate students and parents do not qualify for this type of federal loan. In addition, students who cannot demonstrate financial need won’t be awarded subsidized loans. As of the 2018-2019 school year, the total amount of subsidized loans is capped at $23,000 for the full span of an undergraduate’s education.

 

When comparing subsidized vs unsubsidized loans, you’ll find that subsidized loans are less expensive although the amounts are limited.

 

 

What Is An Unsubsidized Student Loan?

Most other educational loans are unsubsidized. The Federal Direct Loan program offers unsubsidized student loans, and PLUS and private loans are also not subsidized.

 

With an unsubsidized student loan, the borrower is responsible for making interest payments as soon as the loan is issued. This could mean paying interest payments during school, or it could mean adding those interest payments to the principal of the loan, to be repaid after graduation.

 

Direct Unsubsidized loans are not based on financial need, and are available to graduate students as well as undergraduates. They have fixed interest rates, and students need to fill out the FAFSA to apply. The aggregate cap for these loans is $31,000 total. Interest is due immediately, even during the post-graduate grace period and during deferment or forbearance, although it can be added to the principal instead of being paid right away.

 

Other unsubsidized loans have their own terms and conditions. PLUS loans are also through the federal government, and private loans are available from a variety of lenders. In all cases, however, you will find the interest either due during school or added to the balance of the loan and due during repayment.

 

 

How Do You Qualify For A Subsidized Student Loan?

In order to qualify for a direct subsidized loan, you must first file the Free Application for Federal Student Aid (FAFSA) to apply for financial aid through your school. After applying, the school will determine if your family qualifies for need based financial aid

 

To be eligible for a subsidized loan, you must:

  • Be an undergraduate student.
  • Be able to prove financial need.
  • Be enrolled at a school at least half-time.
  • Be enrolled in a program that can lead to a degree or certificate awarded by the school.

What’s important to understand is how colleges determine need and need based financial aid awards.

 

The college must first determine that you have financial need. This is based on your expected family contribution (EFC) and the cost of attendance at the school. If your EFC is less than the school’s cost of attendance, your financial need is the difference of the two.

 

We often hear from parents in our Paying For College 101 Facebook group, why did one school offer my student a subsidized student loan and another school didn’t. It’s because students qualify for need-based aid if your expected family contribution won’t cover the cost of attendance at a particular school, and this varies school to school depending on the school’s cost of attendance.

 

For example, if the school’s cost of attendance is $30,000 and your expected family contribution is $18,000, your financial need is $12,000.  

 

The school may use other grants, scholarships, and need based aid to help cover your financial need. After applying whatever need based monies a school offers and your family still has financial need, the school will offer the difference as a subsidized student loan.

 

Taking the above example further, our example family has a financial need of $12,000. The school offers the student a scholarship worth $8000. Even with the scholarship, the remaining financial need is still $4000. The school will now offer the maximum they can of a subsidized loan and offer the rest as an unsubsidized loan (up to the maximum allowed per school year).

 

For our example family with a financial need of $12,000, the school offers $8,000 as a scholarship and then the maximum the school can offer is $3,500, in a subsidized loan. Since every freshman is allowed to borrow up to $5,500 in federal student loans, in our example family, the student can also borrow $2,000 in unsubsidized loans, if needed.

 

As a freshman, you can take out no more than $3,500 in subsidized direct loans. While the amount gradually scales up to $5,500 a year for juniors and seniors, the lifetime limit on subsidized direct loans for undergraduates is $23,000.

 

 

Why Choosing A Subsidized Student Loan Is Important?

If your student is an undergraduate, it’s vital that they prioritize subsidized loans to save money on school. Not only is the interest taken care of – which can save thousands of dollars – but the fixed interest rates are lower.

 

Other students and borrowers may have fewer choices when it comes to subsidized vs unsubsidized loans. Federal Direct Unsubsidized loans have a lot of advantages over other types. Financial need is not required, and the fixed interest rates are still lower than most private loans.

 

Private loans are probably the last type of funding to consider. Banks require specific creditworthiness, and do not offer the same flexibility with repayment plans, forbearance, and other terms. Even if the private loan interest rate seems lower to start with, most are variable, which means they can go up significantly over time.

 

 

Should You Make Interest Payments While in College?

For those students utilizing the federal unsubsidized student loans, it is often asked whether it is a good idea to begin making payments while the student is in school rather than waiting until the required payments start. The analysis below shows how making voluntary payments early will effect your bottom line. 

 

This analysis assumes that your student is taking the full loan all 4 years of college, it assumes that the loans are disbursed at the beginning of each semester, and it also assumes an average interest rate of 4.5%. This will display the difference between making monthly interest only payments, quarterly interest only payments, an annual interest only payment and making a payment larger than the interest amount.

 

Comparison of Loan Repayment Schedules While In College

 Loan Amount Dispersed
Accumulated InterestInterest PaidPrincipal Paid4 Year Loan Balance
No Interest Paid
$27,000$2,360.26 $0$0$29,360.26 
Interest Only Payment Once Per Month$27,000$0$2,232.19 $0$27,000.00 
Interest Only Payment Once Per Quarter$27,000$0$2,240.42 $0$27,000.00 
Interest Only Payment Oncer Per Year$27,000$0$2,270.37 $0$27,000.00 
$100 Payment Every Month
$27,000$0$1,968.25$2,531.75$24,468.25 

 

Detailed analysis…


The above analysis asssumes all loans are unsubsidized and half is disbursed at the beginning of each semester: Freshman year loan: $5,500, Sophomore year loan: $6,500, Junior year loan: $7,500 and Senior year loan: $7,500 for a total of $27,000 disbursed. Assumes a 4.5% fixed interest rate for the entire 4 years.  Analysis provided by Pamela Heestand, a member of Paying For College 101 Facebook group

 

How Else Can You Save Money on College?

Choosing the right loans and understanding the entire process are major steps in saving money on college. However, they’re only one part of making sure your student has the best (and most affordable) college experience possible.

 

If you’ll be considering private student loans, make sure to use a student loan calculator and compare the total cost of each loan option.

 

CONNECT WITH OTHER PARENTS FIGURING OUT 

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Road2College

Road2College

Debbie Schwartz is former financial services executive and founder of Road2College and the Paying For College 101 Facebook group. She's dedicated to providing families with trustworthy information about college admissions and paying for college. With data, tools and access to experts she's helping families become educated consumers of higher ed.
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