Nearly a third of all college students take out student loans in their own name, according to Sallie Mae, a leading education lender. If you’re one of them, federal loans are by far the best choice.
But even among federal loans, some options are better than others. The federal government offers two types of Direct Loans: Direct Subsidized and Direct Unsubsidized Loans. Undergraduate students may take out federal direct loans at a standardized interest rate, with no credit checks, cosigner, or minimum income requirements.
Direct Subsidized Loans have a lower cost of borrowing since the government pays the interest while the borrower is in school. But there’s a catch — not everyone can qualify for them. Students may be eligible for only one type or a combination of both depending on the information they submit in the Free Application for Federal Student Aid (FAFSA).
Some financial aid is issued on a first-come, first-served basis, so fill out the FAFSA as early as possible to maximize your chances of receiving aid.
Even if you can’t qualify for a Direct Subsidized Loan, federal loans should still be your first choice when it comes to borrowing money for college. Federal loans offer income-driven repayment plans, the potential for loan forgiveness under certain circumstances, options for forbearance and deferment due to financial hardship, and an overall stronger safety net that no private option can match.
Let’s talk about the two types of federal direct loans, how to find out which ones you qualify for, and how to decide which loan is best for you.
Main Differences Between Subsidized and Unsubsidized Loans
Federal Direct Subsidized and Direct Unsubsidized Loans are the two options available to undergraduate student borrowers. Direct Subsidized and Unsubsidized Loans don’t require credit checks or have minimum income requirements, making them useful options for students that may not have much income or credit history yet. These loans are taken out solely in the student’s name, and the student is responsible for repaying them — not the parents.
The major difference between unsubsidized and subsidized loans is interest, according to Jill Desjean, senior policy analyst with the National Association of Student Financial Aid Administrators. The government allocates money, or a subsidy, to cover interest on subsidized loans while the borrower is an active student.
“The student is not responsible for interest [on subsidized loans] while they’re in school or their grace periods,” Desjean says. This helps them save money upfront. Interest resumes once the borrower’s grace period ends, usually six months after graduation.
On the other hand, unsubsidized loans start accruing interest right away. Interest accumulates from the day the student takes out the loan, even if they are not required to make active minimum payments on the principal amount. Any undergraduate student can qualify for an unsubsidized loan if they’re eligible for federal financial aid, but only undergraduate students with significant financial need can qualify for a subsidized loan.
“Financial need is determined by the information included on your FAFSA form,” says Barry Coleman, vice president of counseling and education programs with the National Foundation for Credit Counseling. “Not all students are eligible for Direct Subsidized Loans. In fact, just a small percentage will be. Typically, a lot more are eligible for Unsubsidized Loans.”
Here’s a breakdown of the major differences between Direct Subsidized and Unsubsidized Loans:
|subsidized loan||Unsubsidized Loan|
|Available to||Undergraduate students with demonstrated financial need||All undergraduate and graduate students who qualify for federal financial aid, regardless of demonstrated financial need|
|Annual Borrowing Limit for First-Year Students*||$3,500||$5,500 to $9,500 (based on dependency status)|
|Aggregate Borrowing Limit||$23,000||$31,000 to $57,500 (based on dependency status)|
|Interest Rate for loans disbursed between July 1, 2021 and July 1, 2022**||3.73%||3.73% for undergraduates5.28% for graduates|
|Interest Accrual||No interest accrues while in school, grace periods or periods of deferment||Borrower is responsible for all interest|
**Interest rates on federal Direct Subsidized Loans and Direct Unsubsidized Loans are set by the government and change every year. You can find the current rates as well as rates for previous years on the Federal Student Aid website.
Interest on Subsidized vs. Unsubsidized Loans
Interest rates on federal Direct Subsidized Loans and Direct Unsubsidized Loans are set by the government and change every year. For a given type of loan, the rate is the same for every borrower, regardless of the borrower’s credit score, income, or other financial information. You can see the current rates for different types of federal student loans, as well as rates for previous years, on the Federal Student Aid website.
Although the interest rate is the same on subsidized and unsubsidized loans for undergraduate students, how interest accrues is quite different.
Direct Subsidized Loans
- Interest rate for loans disbursed between July 1, 2021 and July 1, 2022: 3.73%
With Direct Subsidized Loans, interest doesn’t accrue while you’re in college, during your grace period — the six months after you graduate, leave school or drop below half-time status — or any periods of deferment.
Direct Unsubsidized Loans
- Interest rate for loans disbursed between July 1, 2021 and July 1, 2022:
- undergraduate: 3.73%
- Graduates: 5.28%
By contrast, interest starts to build right after your Direct Unsubsidized Loan is disbursed, so paying off your student loan debt can take longer — and be more expensive.
Due to emergency COVID-19 relief measures set by the US Department of Education, the interest rate on most federal student loans (including Direct Unsubsidized and Direct Subsidized Loans) is 0% until May 1, 2022. Loan payments have also been suspended during this time.
Pros and Cons of Direct Subsidized Loans
The core benefit of Direct Subsidized Loans is how interest is handled. With the Department of Education covering your interest charges during certain periods, less interest will accrue and your total repayment cost will be lower.
Direct Subsidized Loans are a good option for undergraduates because they have low interest rates and are eligible for income-driven repayment plans. They’re also qualifying loans for Public Service Loan Forgiveness and Teacher Loan Forgiveness, so borrowers could qualify for loan forgiveness if they work for a qualifying non-profit, government agency, or school.
However, Direct Subsidized Loans aren’t available to everyone. Only students with exceptional financial needs will qualify for subsidized loans. Even if you qualify, you will likely need other loans to pay for the full cost of your tuition because the annual and aggregate limits on Subsidized Loans are quite low.
Interest doesn’t occur during certain periods
Low interest rates
Eligible for multiple repayment plans
Qualifying loan for loan forgiveness
Limited to undergraduate students with significant financial needs
Low annual and aggregate borrowing maximums
Origination fees apply
Pros and Cons of Direct Unsubsidized Loans
Unlike Direct Subsidized Loans, which are only for lower-income undergraduate students, Direct Unsubsidized Loans are for both undergraduate and graduate students, regardless of financial need.
Unsubsidized loans have relatively low interest rates. The rate is 5.28% for graduate borrowers and the same rate as subsidized loans for undergraduate borrowers (3.73%). In addition, unsubsidized loans have higher annual and aggregate borrower maximums.
Direct Unsubsidized Loans share many of the same benefits as Direct Subsidized Loans, including income-driven repayment plans and the potential for loan forgiveness. However, the borrower is responsible for all interest that accrues on unsubsidized loans, starting immediately as soon as the loan is disbursed. Interest is also capitalized, meaning the amount of accrued interest is added to your principal at certain times, such as the end of your grace period. Interest then accrues on the new higher balance, causing your balance to grow faster. Over time, interest capitalization can increase your total repayment cost.
No credit checks
Low interest rates
Higher borrower limits
Eligible for multiple repayment plans, as well as loan forgiveness under certain circumstances
Borrower is responsible for all interest
Graduate students pay higher interest rates
Interest is capitalized
Are Subsidized or Unsubsidized Loans Better?
When it comes to subsidized and unsubsidized loans, subsidized loans are the clear winner. If you can qualify for them, you’ll pay less money in interest charges with a subsidized loan, and you’ll save money over the life of your loan.
But not everyone will qualify for a subsidized loan. Students are often eligible for unsubsidized loans only, or they must use a combination of the two to meet the full cost of college. Unsubsidized loans could be a better choice than other financing options like private student loans because they’re eligible for federal benefits like:
- Income Driven Repayment (IDR): Once your loans are in repayment, you can enroll in an IDR plan. These plans base your payments on a longer term and a percentage of your discretionary income, so you could significantly lower your payment amount.
- Loan Forgiveness: Federal loans are eligible for forgiveness programs like Public Service Loan Forgiveness, Teacher Loan Forgiveness and IDR plan forgiveness.
- Loan discharge: Federal loans can be discharged if you are totally and permanently disabled.
- Forbearance or Deferment: If you return to school, lose your job, or become seriously ill, you can temporarily pause your federal loan payments.
By contrast, private student loans are not eligible for those protections, and they usually have much higher interest rates than federal direct loans. The Institute for College Access & Success reported that the average fixed interest rate for co-signed private loans was 10.2% for 2019 — the last available data.
“With private loans, it’s possible that someone with very good credit or a co-signer may get a better interest rate,” Desjean says. “However, private loans don’t have the same protections as federal loans.”
Who Qualifies for Direct Subsidized Loans?
To qualify for any kind of federal student aid, including Direct Subsidized and Unsubsidized Loans, you must meet the following criteria, according to the Federal Student Aid website:
- You must be a US citizen, permanent resident or eligible noncitizen
- You must have a valid Social Security number (Exceptions apply if you’re from the Republic of the Marshall Islands, Federated States of Micronesia or the Republic of Palau.)
- You must be enrolled in a degree or certificate program at an eligible school
- You must be enrolled at least half-time
- You must be eligible for college by earning a high school diploma, GED or other recognized equivalent
Subsidized loans are only issued to those with demonstrated financial needs. To apply, you must fill out and submit the FAFSA. Based on that information, the government will calculate your expected family contribution (EFC) and share it with your selected colleges. The college then uses the EFC to develop your financial aid package, and will determine if you are eligible for grants, work-study programs, and subsidized or unsubsidized loans.
When exploring financial aid, start early (perhaps before your senior year of high school), and make sure you consider all available options.
“We recommend that students first maximize all the grants and scholarships they can get,” Coleman says. “Next in line, we recommend subsidized loans, followed by unsubsidized loans. Those options would come before considering anything else, like private loans.”
You can start the process by filling out the FAFSA online at www.FAFSA.gov.