Most students need to take out loans to pay for college. But with several different student loan types available, deciphering financial aid award letters can be confusing — especially if you’re a first-time borrower.
But which type of loan you take out can affect how much you owe after graduation — and even how interest accrues with certain government repayment programs. And that can have a lasting effect on the overall cost of your loan and how long you’re stuck repaying the debt.
So when you’re choosing which type of federal student loan to use for college, it pays to know which offers the most benefits.
Subsidized vs. Unsubsidized Loans: Key Differences
Most student borrowers fund their education with low-interest loans called direct loans because you borrow them directly from the U.S. Department of Education (ED).
Those loans are either subsidized or unsubsidized. Subsidized loans are for students with financial need, whereas financial need doesn’t factor into unsubsidized loans.
But that’s not the only difference. And a closer examination of those differences reveals why you should always max out your subsidized loans before taking on unsubsidized ones.
To qualify for federal financial aid, you must fill out a FAFSA (Free Application for Federal Student Aid) every year. You submit the form through your school’s financial aid office rather than submitting it directly to the government.
The form asks about your income and assets. If you’re a dependent undergraduate student, your parents must also provide that information.
Then your school sends you a financial aid award letter, which tells you what you qualify for, including how much you can borrow in subsidized and unsubsidized student loans. The income and assets reported on your FAFSA determine your financial aid eligibility.
To qualify for a direct loan, you must meet the following criteria:
- You’re a U.S. citizen.
- You’ve graduated high school or have a GED.
- You’re enrolled at least half-time in a school that participates in the federal student loan program.
- You’re making satisfactory academic progress.
- You’re not in default on a federal student loan.
Additionally, there are requirements specific to each loan type.
Subsidized Loans Eligibility
Federal direct subsidized loans are only available to undergraduate borrowers who meet financial need qualifications.
According to the ED, “financial need” is the difference between the cost of attendance and the student’s expected family contribution. And you can borrow more in subsidized loans than you need.
You may get different approved amounts from different schools based on their cost of attendance.
Graduate and professional students are ineligible for subsidized student loans.
Unsubsidized Loans Eligibility
Unsubsidized loans are available to both undergraduate and graduate students. There’s no financial need qualification for borrowing federal direct unsubsidized loans. But there are annual and cumulative limits to how much you can borrow, and they vary by year of enrollment.
However, ultimately, your school determines how much you can borrow in unsubsidized loans because you can’t borrow more than what you need to cover your total cost of attendance.
In other words, you can only borrow as much as is required to fill any gap between the school’s established total cost and any other financial aid you receive — including subsidized student loans, scholarships, and grants.
Whether you borrow subsidized or unsubsidized federal direct loans, the interest rates are generally lower than what you’ll get on a private student loan, though PLUS loan rates are higher than other federal loans.
That’s because federal law sets the interest rates, not your credit score. And though the rates vary from year to year, the law caps them at no more than 8.25% (10.5% for grad and parent PLUS loans). Private student loan interest rates can top 14%.
The primary difference between subsidized and unsubsidized student loans is how interest accrues (builds up) on the loans. And it’s this difference that makes subsidized loans the No. 1 choice for financing your education.
Subsidized Loans Interest
A subsidized student loan is not an interest-free loan. All student loans begin to accrue interest the moment the school gets the money. However, borrowers don’t have to pay the interest during certain times.
Instead, the federal government steps in and covers it for them. That’s why it’s called a subsidized student loan. The ED is giving borrowers an interest subsidy during these times.
- While you’re enrolled in school at least half-time
- During the six-month grace period immediately following graduation
- During deferment periods (but not forbearance)
- During the first few years you’re enrolled in an income-driven repayment plan (how much they cover and for how long depends on the plan)
Because the government covers your interest while you’re in school, when you graduate and for the first six months thereafter, the balance is exactly what you borrowed, assuming you didn’t make payments while in school.
So if you borrowed $40,000, that’s what you owe through the first six months after you graduate.
Unsubsidized Loans Interest
The ED doesn’t cover the interest on unsubsidized loans, with the single exception of covering a portion of the interest if you qualify for and enroll in the REPAYE income-driven repayment plan.
That means that even though borrowers don’t need to start repaying until six months after they leave school or drop below half-time, interest begins accumulating from the moment your school receives the loan money.
Worse, after you graduate, that interest capitalizes. That means it gets added to your original balance. And since interest calculates according to your balance, you start racking up interest on top of interest.
For example, if you borrow $27,000, the maximum amount allowed in unsubsidized student loans, during your four years in college at 3.73%, when you graduate, you’ll owe a balance of $28,257. And that’s a low interest rate. It can go as high as 8.25%.
The federal direct loan program has annual and aggregate (total) limits for how much you can borrow in subsidized and unsubsidized loans. Annual and total limits vary by enrollment year, whether you’re a dependent, and whether you’re an undergraduate or graduate or professional student.
Most first-time college students are dependent undergraduates. And all graduate and professional students are considered independent. For the purposes of qualifying for federal student aid, an independent undergraduate is:
- At least 24 years old
- A veteran
- An armed forces member
- An orphan
- A ward of the court
- Someone with legal dependents other than a spouse
- An emancipated minor
- Someone who is homeless or at risk of becoming homeless
The ED also allows dependent undergraduates whose parents don’t qualify to borrow federal direct PLUS loans to borrow up to the higher limits of independent students even though they don’t technically meet the definition.
Regardless of the government limits, you still can’t borrow more than the total cost of attendance minus any other financial aid you receive.
If the federal loan caps on subsidized and unsubsidized direct loans aren’t high enough to meet the difference between your total cost of attendance and your other financial aid, PLUS loans or private loans can help cover any remaining gaps.
Limits also vary based on whether you’re borrowing a subsidized or unsubsidized loan.
Subsidized Loans Limits
For subsidized student loans, the limits are the same for all undergraduates.
|Undergraduate Borrower Limit
(Dependent & Independent)
|First YearAnnual Loan Limit||$3,500|
|Second Year Annual Loan Limit||$4,500|
|Third Year and BeyondAnnual Loan Limit||$5,500|
|Aggregate Loan Limit||$23,000|
Unsubsidized Loans Limits
The caps on unsubsidized direct loans vary by borrower type.
|Dependent Undergraduate Borrowers||Independent Undergraduate Borrowers||Graduate & Professional Students|
|First YearAnnual Loan Limit||$5,500 (minus any subsidized student loans)||$9,500 (minus any subsidized student loans)||$20,500|
|Second Year Annual Loan Limit||$6,500 (minus any subsidized student loans)||$10,500 (minus any subsidized student loans)||$20,500|
|Third Year and BeyondAnnual Loan Limit||$7,500 (minus any subsidized student loans)||$12,500 (minus any subsidized student loans)||$20,500|
|Aggregate Loan Limit||$31,000 (No more than $23,000 can be in subsidized student loans.)||$57,000 (No more than $23,000 of this amount can be in subsidized student loans.)||$138,500 (No more than $65,000 can be in subsidized student loans, and the aggregate limit includes all federal loans for undergraduate study.)|
However, the limit on unsubsidized loans includes any subsidized student loans, meaning you must subtract the amount of any subsidized loans you take out to get your personal borrowing limit. It’s essentially a total cap on all direct loan borrowing.
For example, if you’re a dependent undergraduate and borrow the full amount of subsidized loans your first year ($3,500), you can only borrow another $2,000 in unsubsidized student loans. But if you didn’t qualify for any subsidized student loans, then you can borrow up to the full $5,500 in unsubsidized federal direct loans.
The Verdict: Should You Choose Subsidized or Unsubsidized Loans?
You Should Take Out Subsidized Loans If…
You should max out your subsidized student loan amounts before resorting to unsubsidized loans. But they have added benefits for those who:
- Can’t Afford to Make Interest-Only Payments While in School. Interest starts to accrue on all unsubsidized loans while you’re in school. So if you can’t afford to make interest-only payments, subsidized loans are the solution.
- Plan to Continue Immediately to Grad School. Even though grad students don’t qualify for subsidized student loans, you can defer your undergrad loans interest-free as long as you’re in school.
- Plan to Enter the Public Service Loan Forgiveness Program. If you qualify for public service loan forgiveness, your loan balance can be canceled in as few as 10 years, and your subsidized student loans get additional subsidies on some of the income-driven repayment plans.
You Should Take Out Unsubsidized Loans If…
After you’ve maxed out available subsidized student loans (or if you don’t qualify), turn to unsubsidized loans if you:
- Need to Borrow Above the Subsidized Loan Cap. If you can’t meet the total cost of attendance with your savings and financial aid — including scholarships, grants, and subsidized student loans — turn to unsubsidized federal direct loans before higher-interest PLUS loans or private student loans.
- Can’t Demonstrate Financial Need. Subsidized student loans are for borrowers with financial need. If you can’t demonstrate it on your FAFSA, you won’t qualify for subsidized loans.
- Are Borrowing for Graduate or Professional School. Subsidized federal student loans are unavailable to graduate and professional students, no matter your financial situation.
Both Are Great If…
Although grad students can’t borrow subsidized student loans, both loan options have benefits for undergrad students.
- Your Only Other Option Is a Private Loan. Always borrow federal loans before resorting to private loans. Even in years when the interest rates are higher, most borrowers will find lower interest rates with federal student loans than private ones.
- Can Afford to Make Small Payments While in School. If you can afford to make small payments on subsidized loans, you’ll lower your principal before interest begins accruing. On unsubsidized loans, you’ll prevent the interest they charge while in school from capitalizing. Both mean you pay less over the life of the loan.
- You’re an Independent Undergrad. You may need a little extra if you’re on your own. Fortunately, the ED recognizes that and grants higher limits for independent students. You can use any surplus above your tuition balance to help pay living expenses, which is included in a college’s total cost of attendance.
- You Want Access to All the Federal Student Loan Borrower Benefits. Private student loans don’t come with borrower benefits like flexible repayment options, generous deferment and forbearance terms, and loan forgiveness programs. So even if you can get a better rate, private loans may not be worth it.
The ED offers both subsidized and unsubsidized student loans as part of the federal student loan program. However, if you qualify, you’ll pay less in the long run with subsidized student loans than unsubsidized ones. Thus, you should always max out the full amount of subsidized loans offered in your financial aid package before turning to unsubsidized loans.
And max out both before opting for private loans. Paying less interest reduces the overall cost of your loan. And that means you may be able to pay off your loans faster after you graduate — especially if your new degree helps land you a well-paying new job.