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Subsidized vs. unsubsidized student loans: What’s the difference?

Updated January 10, 2023, 6:55 PM UTC
Photo illustration of two rolls of money wearing graduation caps, one overlaid with blue and the other overlaid with orange.
Subsidized loans are better for those with financial need.
Photo illustration by Fortune; Original photos by Getty Images (2)

The cost of college has skyrocketed over the past several decades. In fact, the average annual tuition bill for a four year public college is now 37 times higher than it was in 1963, according to the Education Data Initiative

Given such statistics, it’s no surprise that students often require financing to help pay tuition and other college-related expenses. For those who use loans to help cover college costs, it’s important to understand the different types of financing available. This is especially critical because some of the lending options allow borrowers to leave school with far less accumulated debt.

Subsidized and unsubsidized student loans, offered by the federal government, are two of the most popular forms of financing. The most notable benefit of subsidized loans is that the interest is deferred while the borrower is attending school at least part time. Interest payments on unsubsidized loans however, begin as soon as the funding is awarded. 

But these are only a few of the differences between the two types of borrowing.

Subsidized loan vs. unsubsidized loan 

Subsidized loans are designed solely for undergraduate students who are able to establish financial need. These loans do not accrue interest as long as the student is attending school at least part-time. In order to be eligible for subsidized loans, student applicants must complete a Free Application for Student Aid (FAFSA) application, which is used to determine how much aid you may be eligible to receive.

Unsubsidized loans are available to undergraduate students, as well as graduate students. Similar to the subsidized loans, applicants must complete the FAFSA to be eligible. However, unsubsidized loan awards are not based on financial need.

“Schools determine how much aid students receive for unsubsidized loans. These decisions are based on the cost of attendance and other financial aid received,” says Meagan McGuire, Student Loan Planner, the largest student loan consulting company in the nation.

Here’s a deeper look at the two different loan types and their pros and cons to keep in mind.

What is a subsidized loan? 

Subsidized loans, which are also referred to as Direct Subsidized Loans and Stafford Loans, are awarded to undergraduate students based on financial need. To qualify, borrowers must complete a free FAFSA application online. They account for about 18.6% of federal student debt.

There are many positive features associated with subsidized student loans, but the most significant is that while a student is in school at least half-time, the loan does not accrue interest. In addition to the interest tab being picked up by the U.S. Department of Education during school, it will also be paid for the first six months after you complete school. This is known as the grace period, according to the U.S. Department of Education website.

“That is the largest benefit of a subsidized loan because…you’ll have less to pay back later,” says Jeff White, financial advisor with Saving for College, an online informational resource focused on saving and paying for college.

Yet another benefit associated with these loans is that the interest rate is often lower than unsubsidized loans. It’s also worth noting that if you’re having trouble repaying the loan after school, there are programs available that allow for deferment, longer-term forbearance, or income-based repayment. 

How subsidized loans work

Here’s a closer look at how to obtain a subsidized loan and how they work once awarded.

  • Complete a FAFSA. In order to be eligible for a subsidized student loan you must first complete a FAFSA application online. This application is used by the U.S. Department of Education to gauge how much financial aid you qualify for, if any at all.  
  • Award of aid eligibility notification. Once the application review process has been completed, you will be notified regarding your financial aid award.
  • Interest paid by the U.S. Department of Education. As long as you’re enrolled in school at least half-time, the interest on the loan will be paid by the government and for six months after you leave school, which is known as the grace period.
  • Begin making payments. After six months, you must begin repaying your loans or apply for a deferment, forbearance, or income-driven repayment, if need be.

Pros and cons of subsidized loans 

While there are many benefits to subsidized loans, there are also a few drawbacks to consider.

  • Pro: Deferred interest. As long as the borrower is in school at least half-time, the interest on these loans is paid by the U.S. Department of Education. 
  • Pro: Grace period after graduation. The government will also continue to pay the interest subsidized loans for the first six months after borrowers leave school. This is known as the grace period. 
  • Pro: Deferment availability. If you’re having trouble making payments, you can temporarily defer or postpone repayment of these loans or apply for income-driven repayment.
  • Pro: Lower interest rates. The interest rate associated with subsidized loans is lower than that of unsubsidized loans. It is currently 4.99%, according to the U.S. Department of Education.
  • Cons: Lower lending limits. For a first-year, dependent undergraduate student the borrowing limit is $3,500 in subsidized loans. For a second-year undergraduate student, the borrowing limit is $4,500; for third- and fourth-year students, the limit is $5,500.
  • Con: Must establish financial need. Subsidized loans are only awarded to those who can clearly document financial need. 
  • Con: Only open to undergraduate students. Graduate students are not eligible for subsidized student loans.

What is an unsubsidized loan? 

The U.S. Department of Education also provides unsubsidized loans. These are sometimes referred to as Direct Unsubsidized Loans and Stafford Loans and are loans available to both undergraduate and graduate students to cover the cost of college. Because the awards are not based on financial need, more applicants tend to qualify for unsubsidized loans.

The interest on these loans begins accruing immediately after the funds are made available. “Instead of the interest being paid for you, you’ll be in charge of the interest from the moment the loan dollars hit your account or are sent to your school,” says White. “You won’t necessarily have to make payments right away while you’re still attending school, but the interest will continue to accumulate.”

How unsubsidized loans work 

Similar to subsidized loans, qualifying for an unsubsidized loan requires completing a FAFSA application. Though these loans are not awarded based on financial need. Here are some of the facts about how these loans work:

  • Once you complete the FAFSA, the school that you plan to attend will generally include any unsubsidized loan awards in your financial aid package if you have a funding gap or shortfall.
  • As with subsidized loans, you will not need to make payments while attending school at least half-time. In addition, you will have a six-month grace period once you complete school before you must begin repayment. 
  • However, interest on unsubsidized loans does begin accruing immediately, even during the nonpayment period. You have the option to begin repaying interest during school.

Pros and cons of unsubsidized loans 

Similar to subsidized loans, there are pros and cons to unsubsidized borrowing. Here’s a look at some of the considerations: 

  • Pro: Accessible to more students. Because it is not necessary to demonstrate financial need, unsubsidized loans are open to more borrowers.
  • Pro: Larger borrowing amounts available. For undergraduate students, the borrowing limit is $34,500, while for graduate students it is $20,500 per academic year.
  • Con: Interest begins accruing immediately. This means you will have a larger amount of student loan debt once you complete schooling.
  • Con: Higher interest rates than unsubsidized loans. The current interest rate on these loans is 6.54%

How to choose between subsidized and unsubsidized loans 

Ultimately, subsidized loans are better for those with financial need, but they are also a wise choice simply to minimize the total amount of student debt you end up with after completing school. However, those who have larger borrowing needs than subsidized loans allow may find it necessary to supplement with unsubsidized loans.

“Unsubsidized loans accrue interest from the day they are disbursed to the school and during all other periods regardless of loan status,” says Betsy Mayotte, president and founder of the Institute of Student Loan Advisors (TISLA), a 501(c)(3) that offers advice and resources for students. “For those reasons, subsidized loans are often less expensive over the long run for student loan borrowers, as they at least don't have to contend with the interest that accrued while they are in school.”

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