Should I get a subsidized or unsubsidized loan? Let’s answer this question in detail by explaining both loan types. Choosing a suitable loan is a crucial decision because repayment can last up to 25 years. Therefore, making the right decision ensures a smooth, stress-free student loan repayment process. This guide focuses on the difference between subsidized and unsubsidized loans, allowing the students in need to choose the best federal loan program for them.
The Direct Loan program is also called the William D.Ford Federal Direct Loan program. It aims to become an affordable source of financing for students and their parents to cover educational costs. In this program, the sole lender is the Education Department. Besides, the Direct Loan program is the only program backed by the government.
Such centralization of loan distribution allows the government to get better control over the processes so that no single private company can abuse the borrowers’ needs.
Although George Bush authorized the Direct loan program in 1992, Barack Obama was the one who organized all new loans under this program in 2010. All loans were gathered under one roof – Direct lending- in that year through the Health Care and Education Reconciliation Act.
Currently, the government’s direct loan portfolio is worth more than $1.5 trillion, which creates concerns about defaults- the case when borrowers are not able to repay high debt. The borrowers get four different types of loans through this program:
- Direct subsidized loan
- Direct Unsubsidized loan
- PLUS loan
- Direct consolidation loan
Direct Subsidized Loans
Undergraduate students can get Direct subsidized loans to cover educational expenses. These loans are distributed based on the financial needs of applicants. If an applicant can prove a high financial need for the loan to finance education, she/he will be able to get a subsidized loan.
As financial challenges are central to this loan, its interest rate and other terms are usually more favorable. However, graduate and professional students cannot apply for this loan type.
Direct Unsubsidized Loans
As the name suggests, these loans are not based on financial needs. Hence, there is no need for proving a financial challenge to qualify for the loan. This feature of the loan makes it both advantageous and disadvantageous.
On the one hand, it is easier to qualify. On the other hand, as financial need is not a concern, the loan usually has a higher interest rate, which means it is not as affordable as subsidized loans. Thus, financial need is a major difference between subsidized and unsubsidized loans.
Direct PLUS Loans
These loans are available to graduate/professional students and parents of undergraduate students. When made to students, it is called Graduate PLUS loan, while in the second case, it is called Parent PLUS loan. Usually, PLUS loans cover the educational expenses that other financial aid programs do not cover.
Different from both subsidized and unsubsidized loans, PLUS loans require credit checks. You need to have a good credit score to become eligible for this loan type.
Direct Consolidation Loan
Consolidation loans aim to combine/consolidate multiple student loans into one with no further costs. Usually, when borrowers are lost among many loan payments, they consolidate the loan to have a single payment per month.
In such cases, the loan interest rate is the weighted average of all existing student loans. It means there is no saving through a reduced interest rate in the consolidation program. It only helps to simplify the process.
Difference between Subsidized and Unsubsidized Loans
This guide focuses on two types of Direct student loans, particularly subsidized and unsubsidized loans. These programs are similar but with a few differences. In general, the application process and the repayment are proceeding in the same way. Yet, eligibility conditions, interest rates, loan amounts per program can be varying.
In short, subsidized loans are need-based. Hence, they mostly have lower interest rates. Besides, subsidized loans are only available to undergraduate students. Lastly, loan limitations are in lower amounts for subsidized loans. On the other hand, unsubsidized loans do not require borrowers to prove a financial need. Undergraduate, graduate, and professional students can qualify for this funding source. However, its interest rate can be higher.
1. Eligible Borrowers
One of the main differences between subsidized and unsubsidized loans is that the former one is need-based financial aid. Only students lacking financial resources in the family can qualify for subsidized loans.
Usually, financial need is determined by deducting the Expected Family Contribution amount from the cost of education. If the difference is large, the students might qualify for subsidized loans. Meanwhile, unsubsidized loans do not require the borrower to demonstrate a financial need.
The advantage of subsidized loans being dependent on financial need is that they become cheaper. In other words, the terms for subsidized loans are easier because its borrowers cannot afford highly expensive sources of funding. Yet, financial need is a pre-condition that a student should qualify to get the subsidized loan, making it more challenging to access.
Additionally, only undergraduate students can be eligible for Direct subsidized loans. Therefore, even if graduate students can demonstrate their needs, they will not qualify for such loans. Meanwhile, both undergraduates and graduate can finance their education through Direct unsubsidized loans.
2. Loan Amount
There is a difference between subsidized and unsubsidized loans in terms of how much you can borrow. The exact amount of loan depends on many factors. Rather than being subsidized and unsubsidized, there are differences based on annual limits and aggregate limits. In turn, they depend on the study year and the status of students.
First, annual limits indicate how much a student can borrow during each academic year. The next aggregate loan limit indicates the amount a student can borrow for the whole study period. For example, if you are a first-year dependent student, your annual loan limit is $5.500. Out of this amount, only $3,500 can be subsidized. As you become a second or third-year student, the loan limit increases.
In general, for undergraduate students, the annual limit is higher if they are independent. However, the amount qualifying for subsidized loans does not change.
In the case of graduate and professional students, they are considered independent students. Besides, they can only get unsubsidized loans. The annual loan amount for such students is $20,500. For more details on loan amounts, check the official Student Aid website.
Keep in Mind
If you reach the aggregate loan limit, you cannot borrow anymore. You can get more loans only if you repay some amount. In this case, the outstanding debt balance will decrease and be lower than the limit.
Another difference between subsidized and unsubsidized loans exists in their repayments. In general, federal student loan borrowers are not required to repay the loan while studying and six months after graduation (which is called a grace period). However, if a student graduates or drops below half-time study, or six months pass after graduation, she/he should start the repayment.
There exist different student loan repayment plans for federal borrowers:
- Standard Repayment Plan
- Graduated Repayment
- Extended Repayment
- Income-Driven Repayment
Almost all plans are available to both Direct subsidized and unsubsidized loans. However, there can be differences within the repayment plans depending on which type of student loan you have. For example, the repayment period for the Revised Pay as You Earn plan (one of the four categories of Income-Driven Repayment) is 20 years for undergraduates and 25 years for graduate/professional students.
Keep in mind that graduate and professional students can only qualify for unsubsidized loans. Additionally, the repayment amount, which is determined by interest rates, is different for subsidized and unsubsidized loans. We will discuss these differences in the next section.
4. Interest Rates
Interest rate is a major factor influencing the decision of whether to get student loans. As mentioned, subsidized loans are need-based. Therefore, students must demonstrate the financial need to get these loans. Meanwhile, unsubsidized loans have no such requirement making the qualification easier.
Yet, borrowers with financial needs qualify for lower interest rates. Between July 1, 2020- July 1, 2021, the interest rate for subsidized loans (only for graduates) was 2.75%. However, this year, the federal student loan rates increased. For the current year, between July 1, 2021- July 1, 2022, this rate is increased to 3.73%.
The rate for graduate and professional students (only unsubsidized loans) is 5.28% for this year, while it was 4.3% last year.
Keep in mind that the increase depends on external factors. Mainly, the rate is based on the auction of 10-year Treasury notes. Hence, it is hard to predict whether the rates will increase or decrease next year.
5. Loan Fees
Although federal loans are cheaper options than private student loans, there are still some costs involved. We already discussed the difference between subsidized and unsubsidized loans in terms of interest rates. Yet, there is another fee paid in addition to the interest rate. This loan fee applies to all subsidized and unsubsidized loans. Rather than being paid continuously, the loan fee is a one-time payment.
The fee is the same for subsidized and unsubsidized loans. What matters is the first disbursement date of the loan. For example, borrowers who got their loans between October 2019 and October 2020 paid 1.059% of the loan amount.
Meanwhile, borrowers receiving their first disbursement between October 2020 and October 2022 face a 1.057% loan fee. Keep in mind that the fee is not deducted wholly from the first disbursement. Usually, schools disburse the loan amount in two or more disbursements, and the deduction of the fee is proportional.
6. Application Process
There is almost no difference between subsidized and unsubsidized loans in terms of the application process. The application to federal loans is centralized; every applicant needs to submit FAFSA -Free Application for Federal Student Aid. After the submission, the school uses this form to evaluate the case and determine the loan amount you might qualify for.
Once the borrowers successfully qualify for the loans, they will be required to continue with further steps. If it is the first time you are receiving a Direct loan, you will be required to complete entrance counseling. This counseling tool helps borrowers understand their obligations better and realize the repayment process from A to Z.
Next, signing a Master Promissory Note is necessary. It is a legal document that indicates the loan terms like interest rate, repayment conditions, etc. The borrowers are required to agree to these terms and sign the document.
Some people might wonder if there is a difference between subsidized and unsubsidized loans regarding time limitations. Such limitations mainly apply to subsidized loans rather than unsubsidized ones. First, keep in mind that there is no time limitation if your loan was disbursed after July 2021. Time limitations indicate how long a borrower can take loans to finance education. For borrowers receiving the loan after July 2013 and before July 2021, a time limitation, which is the maximum eligibility period is applicable. In other words, borrowers could apply for loans only for 150% of the length of the study program. So, for example, if you study a four-year bachelor program, you can get subsidized loans only for six years, 150% of four years.