What's the Difference? Subsidized vs Unsubsidized Loans

If there's a gap between what you actually have to pay for college and your school's price tag, you might be considering taking out student loans. What you might not know is that there are different types of student loans, with different terms and restrictions.

First, we'll cover the basics of what it means to take on student debt. Then, we'll walk you through the differences between two major federal loan types: Direct Subsidized and Direct Unsubsidized. If you want a quick overview, just jump to the end of the article for a side-by-side comparison!

First of All, What Does It Mean to Take Out a Loan? 

It's not uncommon for there to be a gap between what students can afford, and what college actually costs. This is where student loans come in: you can borrow money to pay for school, with the understanding that you'll pay it back (in addition to a bit extra) after you graduate. The amount of money that you actually borrow is called the principal, whereas the "extra" amount is called interest. 

A Little More About Interest

Interest rates are always set as a percentage, so when you pay back your loan (principal + interest), you're paying back what you borrowed plus a percentage of what you borrowed. Lower interest rates = better loans, because the percentage of "extra" money you have to pay back is smaller. 

Here's a very simple example to demonstrate what I mean:

If I borrow $100 with an annual interest rate of 10%, and I want to pay off the principal + interest in full one year later, I would owe $110 ($100 principal + 10% of $100 = $110). If I had an interest rate of 1%, though, I would only owe $101. Student loans work in the same way, although students usually borrow a bit more than $100. 

 The amount of money you actually end up paying back depends of course on your loan principal and interest rate, but also on how often your interest capitalizes. Capitalization is when accrued (accumulated) interest is added to your principal, so you would pay interest on your original principal + capitalized interest. Bigger principal = more interest, so the less often your interest capitalizes, the better. 

The amount of money you end up paying back in interest also depends on how long it takes you to pay off your loan. You usually don't pay off your loan at once; you make monthly payments on interest + part of your principle. Many student loans set monthly payments that assume you will pay off your loan in 120 months, but you are free to make more than the minimum payments. The longer it takes you to pay your loan, the more interest accrues. 

All loans charge interest, but some lenders offer better interest rates than others. The federal government tends to offer comparatively low interest rates to student borrowers; in the rest of this post, I'll be discussing the two major types of federal student loans. 

The lower your interest rates, the less you'll owe in the long run.

Direct Subsidized Loans

Direct Subsidized loans are meant to help eligible students pay for the cost of higher education. The thing that's most unique about Direct Subsidized loans is that the U.S. Department of Education pays the interest on your student loans during certain periods. When your interest is being paid, it can't accrue or capitalize, so your principal doesn't grow (this is a good thing)!

If you have a Direct Subsidized loan, you won't accrue any interest during the following periods: 

• when you're in school at least half-time
• for the first 6 months after you leave school (this is called a grace period)
• during a period of deferment (a postponing of loan payments)

You can apply for a Direct Unsubsidized loan by submitting a Free Application for Federal Student Aid, or FAFSA. 

Eligibility & Limits

First, because Direct Unsubsidized loans are forms of federal student aid, you must meet all federal student aid requirements to be considered eligible. You can get more information about these requirements here.

Direct Subsidized loans are only available to undergraduate students with financial need. Your school ultimately decides how much you can borrow; the amount cannot exceed what they determine to be your financial need. 

There is a maximum eligibility window for you to receive Direct Subsidized loans, equivalent to 150% of your program length. For example, if you're enrolled in a 4-year college, you can only receive subsidized loans for 4*150% = 6 years. If you're enrolled in a 2-year college, your limit would be 2*150% = 3 years. 

Finally, there's a limit to how much you can borrow in Direct Subsidized loans - this amount depends on your year in school. The following chart outlines the annual limits and the lifetime max for Direct Subsidized loans.

Direct Unsubsidized Loans

Direct Unsubsidized loans are similar to Direct Subsidized loans in that they're meant to help students pay for the cost of higher education. Unlike Direct Subsidized loans, interest starts accruing as soon as the loan is disbursed (paid out). You do not have to make payments while you're in school, or during a grace or deferment period. 

You can apply for a Direct Unsubsidized loan by submitting a FAFSA. 

Eligibility & Limits

Direct Unsubsidized loans are a bit more flexible than Direct Subsidized loans. You still must meet all federal student aid requirements to be eligible, but these loans are available to both undergraduates and graduates. Additionally, you're not required to demonstrate financial need in order to get an unsubsidized loan. 

Ultimately, your school will determine how much you can borrow depending on your cost of attendance and the rest of your financial aid package. For example, if your cost of attendance is covered by grants, scholarships, and Direct Subsidized loans, you may not be able to take out a Direct Unsubsidized loan. 

Unlike Direct Subsidized loans, there is no maximum eligibility window or period. There is a maximum borrowing amount, which depends on your year in school. All the maximums below also include any federal subsidized loan amounts (for example, if you're a dependent student who receives $1,000 in Direct Subsidized loans your freshman year, you could take out a max of $4,500 in Direct Unsubsidized loans):

Loan Interest Rates & Fees

I've discussed how important interest rates are when you're considering taking out student loans. When you take out loans from a private lender (from a bank, from example), interest rates may vary based on credit history. Federal student loan rates for Direct Subsidized and Unsubsidized loans are standardized, and are typically pretty low; this means that interest rates are the same for all students, regardless of personal or parental credit history. 

This chart shows interest rates based on loan type and borrower type for loans disbursed (paid out) before 7/1/2016: 

First Disbursement Date	Loan Fee
On or after 10/1/14 and before 10/1/15	1.073%
On or after 10/1/15 and before 10/1/16	1.068%

 

 

A Real-Life Example

You've just been presented with a lot of information about the differences and similarities between subsidized and unsubsidized loans. I've come up with an example based on typical student debt amounts so that you can see different financial outcomes based on subsidized vs. unsubsidized loans. 

The average student has about $26,000-$29,000 in federal student debt at graduation from a 4-year college (students who have graduated from private schools tend to be at the higher end of that range, whereas students from public schools tend to be at the lower end). That comes out to about $7,000 in loans per year. 

For the sake of this example, let's say I take out the maximum amount in subsidized loans my freshman year ($3,500), and take out another $3,500 in unsubsidized loans for a total of $7,000. Interest will accrue while I'm in school on my unsubsidized loan, so my balance due at graduation will differ significantly based on loan type, even though the original principals were the same. I would end up paying about $900 more on my unsubsidized loan than on my subsidized loan. 

 

	UNSUBSIDIZED	SUBSIDIZED
Amount Borrowed	$3,500	$3,500
Interest Rate	4.29%	4.29%
Interest Accrued During School (4 years)	$640	$0
Balance Owed at Graduation	$4,140	$3,500
Time to Payoff at $50/month (Interest accrues for both subsidized and unsubsidized loans during this period)	99 months	81 months
Total Amount Paid	$4,950	$4,050

Usually, standard loan repayment happens over 120 months, not 99 or 81. Minimum monthly payments for these loans are $50, though, which is why the repayment periods are a bit shorter here. 

Most students who take out federal loans have some combination of subsidized and unsubsidized. The average 4-year college graduate will have monthly student loan payments of about $275 on the standard 10-year repayment plan, and will ultimately pay back $32,600 in principal + interest. 

 

Side-by-Side Comparison

We've gotten into all the nitty-gritty details, but here I've put everything together in an at-a-glance reference. If you're looking for distilled information on the differences between Direct Subsidized and Direct Unsubsidized loans, this is the section for you. For any points of clarification, just refer back to the corresponding sections earlier in the post. 

 

	DIRECT SUBSIDIZED LOAN	DIRECT UNSUBSIDIZED LOAN
Lender	Federal government	Federal government
Interest accrual during school, grace period, deferment period	NO	YES
Eligibility	Undergraduate only	Undergraduate & graduate/professional
Must demonstrate financial need?	YES	NO
Maximum eligibility window	YES (150% length of program)	NO
Maximum award amount	YES (see chart above)	YES (see chart above)
Interest Rate (7/1/15-7/1/16)	4.29%	4.29% undergraduate 5.84% graduate/professional
Loan Fee	1.073% 10/1/14-9/30/15 1.068% 10/1/15-9/30/16	1.073% 10/1/14-9/30/15 1.068% 10/1/15-9/30/16
Application	FAFSA	FAFSA

 

What's Next?

Loans aren't the only type of federal financial aid. Want to learn about money that you don't have to pay back? Check out our guide on how to get a Pell Grant.

Before you apply, learn more about Pell Grant eligibility requirements, limits, and application instructions.