Subsidized vs Unsubsidized Student Loans

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subsidized vs unsubsidized student loansWhen students head off to college, there’s one thing everyone learns real fast: College financing is complicated.

You may be offered grants and scholarships, which do not have to be repaid as long as you keep your end of the academic deal, on top of a litany of different student loan options.

Two such loans you’re likely to be offered are Direct Subsidized Loans and Direct Unsubsidized Loans. Direct Subsidized Loans and Direct Unsubsidized Loans are very similar with one major difference. If your loan is subsidized, the federal government will pay the interest on your loan while you’re in school at least half-time and the first six months after your graduation.

Direct Subsidized Loans

Direct Subsidized Loans are preferable to Direct Unsubsidized Loans as the federal government will pay the interest on the former but not the latter while you’re a student.

However, access to subsidized student loans is limited by income; if you or your guardian(s) make too much, you may not qualify.

Pros of Subsidized Student Loans

  • The federal government pays interest for you while you’re in school or a grace period.
  • Can be repaid using virtually any federal repayment plan, which may allow your loan to be forgiven or canceled over time depending on your individual circumstances.

Cons of Subsidized Student Loans

  • Available based on financial need.
  • Not available to graduate students. You can only carry over $65,500 in subsidized loans from your undergraduate work as you move into your professional studies.
  • Direct Subsidized Loans are not on the same playing field as grants and scholarships, which you should not have to repay. While you don’t pay interest on your subsidized loans while you’re in school, you will be required to pay both towards your principal and interest after you’re six months out of school.

Direct Unsubsidized Loans

Direct Unsubsidized Loans do not come with the offer of the government paying your interest for you while you’re in school. That means you’ll either have to pay the interest as your pursue your studies, or you’ll have to swallow the fact that your debt is going to grow larger as that interest accumulates and is applied to your principal balance.

Unlike Direct Subsidized Loans, Direct Unsubsidized Loans do not come with income restrictions. However, your school can still set a max limit after looking at the cost of tuition and any other financial aid you may be bringing in.

Pros of Unsubsidized Student Loans

  • Eligibility not based on income.
  • Available to graduate students.
  • Can be repaid using virtually any federal repayment plan, which may allow your loan to be forgiven or canceled over time depending on your individual circumstances.

Cons of Unsubsidized Student Loans

  • You will have to pay interest through school, grace periods and deferments unless you want that interest to accumulate on your principal balance.
  • It may make sense to take out as much as you can in subsidized student loans and then fill the difference with unsubsidized loans. Because subsidized loans are more advantageous, they should be less expensive to pay back.

How to Take out Direct Student Loans

To take out Direct Student Loans — whether they are subsidized or unsubsidized — you will first need to fill out the free application for Federal Student Aid (FAFSA).

You can fill out the FAFSA as early as the October before the Fall semester. Doing so will put all your financial data into a complex algorithm which the Department of Education uses to figure out how much aid you qualify for. Your college or university then runs the numbers so they can get together their institutional aid package, too.

When you get your FAFSA eligibility results back, look for grants, first. These grants do not have to be repaid as long as you perform well in school. That makes them superior to any type of loan.

Most people are likely to qualify for Direct Unsubsidized Loans, but if you’re lower- or middle-income, you may also qualify for some Direct Subsidized Loans.

Should You Take out Direct Student Loans?

You might qualify for student loans, but does that mean you should take them out? Whether your loans are subsidized or unsubsidized, you will have to pay them back with interest. While it’s true that you’ll pay more interest with a Direct Unsubsidized Loan, that doesn’t mean the Direct Subsidized Loan is free.

Before you take out student loans, scour your community, professional organizations and school for potential scholarships. Combine these with the grants offered to you on the FAFSA and get as close to funding your education debt-free as possible.

Then, and only then, should you consider taking on student debt. Whether or not an expensive education is a good return on investment for you will depend on the interest rate you are offered, the career opportunity waiting for you on the other side of that degree and the overall affordability of your college or university.

Repayment Plans for Direct Subsidized and Unsubsidized Loans

Both Direct Subsidized and Unsubsidized Loans are repayable under almost any federal repayment plan. Each has its own set of advantages.

You can talk to your loan servicer about switching between plans if that ends up being the right course of action for you.

Bear in mind that any plan that forgives a debt is going to cause your tax burden to increase that year. If your creditor forgives $2,000 worth of debt, it’s effectively added to your 1040 as $2,000 in taxable income.

Standard Repayment Plan

This is the default option with fixed monthly payments that will get your loan paid off in ten years.

Revised Pay as You Earn (REPAYE)

You pay ten percent of your discretionary income every month towards your student loan debt. After 20 years of payments, the rest of your debt will be forgiven. Graduate students have to wait 25 years for the debt to be forgiven.

Income-Based Repayment (IBR)

If you enter into an IBR plan, your monthly payments will be capped at ten percent of your discretionary income or whatever your payment would be under the Standard Repayment Plan — whichever is less. Any remaining debt will be forgiven after 20 years.

Income-Contingent Repayment (ICR)

On an ICR, your max monthly payment would be the lesser of 20% of your monthly income or the amount you would pay under a 12-year repayment plan with fixed, monthly payments. Any remaining debt will be forgiven after 25 years.

Restructuring Your Student Debt

Interest rates for student loans were particularly high prior to the Recession. If you took out your loans when rates were higher than they are today, you may have considered consolidating or refinancing.

Federal Student Loan Consolidation

When you consolidate your federal student loans, you’re putting them all in the same pot. To figure out the new interest rate for this new loan, the Department of Education averages together the interest rates of whichever loans you’re putting into that pot. This will inherently give you a new rate that’s lower than what you were paying on some of your loans, but higher than you were paying on others.

As long as you are only consolidating Direct Loans, you will still be eligible for all of the same repayment plans.

Refinancing on the Private Market

Refinancing your student loans on the private market may or may not give you a lower interest rate, but you’ll also be giving up the benefits of holding your student debt with the federal government.

You won’t be eligible for advantaged repayment plans like REPAYE and IBR, and you won’t be eligible for loan cancellation programs like Public Service Loan Forgiveness (PSLF) or Teacher Loan Forgiveness.

What is Better Subsidized or Unsubsidized Loans?

If you’re going to borrow money, take advantage of as much of your Direct Subsidized Loan offer as possible. By prioritizing subsidized over unsubsidized, you’re reducing how much your debt can grow.

Direct Subsidized and Unsubsidized Loans are sometimes a necessary part of the funding puzzle if you want to finish college traditionally.

While grants and scholarships are always a preferable way to get money for school, these loans can help fill in the gaps.

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