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Unsubsidized vs. Subsidized Loans

As you celebrate your college acceptances, there’s no doubt you have many questions about what’s coming next. A major question (and potential concern) for many students is college affordability. The good news is that you’re not alone. Approximately 69% of college students graduate with student loan debt, and as long as you are careful to make appropriate financial decisions based on your personal circumstances, it’s entirely possible to take on loans that will not overburden you upon graduation.

First, let’s discuss who needs loans. If you cannot cover the college’s cost of attendance on your own (which factors in tuition, room and board, fees, books, personal expenses, and potential transportation costs) you will have to consider various forms of financing. This financing can come in the form of scholarships, grants, federal loans, work study, Parent PLUS loans, or private loans, and colleges will outline their potential offer for each in your financial aid award letter.

How It Works

If you do need to take on a loan, you have several factors to consider. Interest is the extra percentage you pay back on the unpaid amount of what you initially borrowed (the principal), and a higher rate means you pay back more over time. Interest accrues daily at either a fixed or variable rate. Your interest can also capitalize, meaning that accrued interest is added to the principal. Capitalization can be triggered by a number of different factors, such as when a loan enters repayment, a deferment ends, or a repayment plan changes, so make sure to find out how often your loan will capitalize and what you can do minimize the amount that capitalizes. An additional factor that determines how much you will pay is the time it takes to pay off the loan in full. Overwhelmed yet? Here’s an example that should help you compare a few different scenarios:

Loan Amount$10,000$10,000$10,000$10,000
Interest Rate5%5%7%7%
Monthly Payment$106 (lowest minimum payment)$150$116 (lowest minimum payment)$150
Time to Pay Off120 months (full term)79 months120 months (full term)85 months
Total Paid$12,727$11,739$13,932$12,700
Total Interest Paid$2,727$1,739$3,932$2,700

In this table, you can see why interest rates and repayment time matter. You’ll end up paying about $1205 more with a 7% interest rate rather than a 5% rate on the same amount. You can also see the difference between making minimum payments for the full term of the loan (10 years, in both cases), or making slightly higher payments of $150/month. On the 5% loan, you’ll save $988 by making higher payments, and pay the loan off 41 months early. You’ll save $1232 on the 7% loan, and reach final payoff 35 months early. Loan calculators like this one can help give an estimate of what to expect, although they won’t replace discussing your exact loan terms and repayment plan with your lender.

This brings us to the type of loans you can take out. A private loan is one financed through a non-federal lender, often coupled with higher interest rates and stricter terms. A federal loan is funded by the government, often with lower interest rates and more flexible terms. Today, we are going to explore the two most popular types of federal loans: Direct Unsubsidized and Direct Subsidized.

Direct Subsidized Loans

These are loans that allow students with demonstrated need to borrow funds for college at interest rates lower than most private loans. If you are granted a subsidized loan, you do not have to pay interest while you are in school. The interest that accrues on the loan is paid by the government as long as you are in school at least half-time. Repayment is deferred for a six month “grace period” after you graduate or leave school, and you are also not responsible for paying back the interest that accrues during this time. The maximum eligibility period to receive a subsidized loan is 150% of the length of your current program (ex. a 4 year program would equal 6 years of loan eligibility). Right now, the interest rate for subsidized loans disbursed between on or after July 1, 2015 and before July 1, 2016 is fixed at 4.29%.

Direct Unsubsidized Loans

You do not need to demonstrate financial need in order to be eligible for an unsubsidized loan. However, repayment begins immediately, unless you decide to defer until after you graduate or leave school. Unlike subsidized loans, interest that accrues during college is not paid by the government and is your responsibility. There is no maximum eligibility period, and unsubsidized loans are available to both undergraduate and graduate students. The current interest rate for unsubsidized loans disbursed on or after July 1, 2015 and after July 1, 2016 is 4.29%.

Which type is better?

The interest rate is the same for subsidized and unsubsidized loans. If you have a choice, a subsidized loan is the best type to take on, because it saves money in interest over time. However, you must demonstrate financial need to be offered a subsidized loan. Since repayment begins immediately with an unsubsidized loan, you will end up paying more over time, but it is still a better option than a private loan.

In addition to the attractive rates, federal loans often have flexible repayment options and may also offer loan forgiveness programs if you have a certain public service jobs and meet additional conditions. Also, interest is fixed on both types of loans for all students regardless of credit history, so subsidized and/or unsubsidized loans can be a great way to build credit.

Is there anything else I need to know?

Both subsidized and unsubsidized loans have a loan fee, which is a percentage of the total loan amount that is subtracted from each disbursement you receive. It is your responsibility to pay back the full amount you borrowed, not just the amount you received less the loan fee. For loans disbursed on or after October 1, 2015 and before October 1, 2016 the loan fee is 1.068%.

Am I eligible for a Direct Loan?

You’re eligible for a Direct Loan if…

  1. You are enrolled in school at least half time.
  2. You are enrolled in a program that leads to a degree or certificate offered by the school.
  3. (Subsidized loans only) You demonstrate financial need.

Great! I’m eligible. Now what?

You must fill out the FAFSA in order to apply for a Direct Loan. The colleges that accept you will then use the information you provided on your FAFSA application to determine your financial aid package and the loan amounts you are eligible to receive.

How much can I receive?

Dependent studentsIndependent students
First Year Undergraduate Loan Limit$5,500 (no more than $3,500 in subsidized loans)$9,500 (no more than $3,500 in subsidized loans)
Second Year Undergraduate Loan Limit$6,500 (no more than $4,500 in subsidized loans)$10,500 (no more than $4,500 in subsidized loans)
Third Year and Beyond Undergraduate Loan Limit$7,500 (no more than $5,500 in subsidized loans)$12,500 (no more than $5,500 in subsidized loans)
Graduate/Professional Annual Loan LimitNot applicable, as all graduate/professional students are considered to be independent for financial aid purposes.$20,500 (unsubsidized only)
Subsidized and Unsubsidized Lifetime Loan Limit$31,000 (no more than $23,000 in subsidized loans)$57,500 for undergraduates (no more than $23,000 in subsidized loans)

So, if you are a freshman who is offered the maximum amount of federal aid, you can borrow $3,500 in subsidized loans and $2,000 in unsubsidized loans.

Should I always accept federal loans as part of my package?

You should only consider loans (both federal and private) after you have exhausted your avenues for gift aid and earned aid. Gift aid (grants and scholarships) is the best type of aid because it does not have to be paid back. Earned aid (work study) allows you to work part-time in order to help pay for educational expenses. If you still need additional funding after gift aid and earned aid awards have been calculated, consider financing as much remaining need as possible with federal loans. Even though there’s a cap on what you can borrow, federal loans are typically the smartest choice since they offer the lowest interest rates. Some private loans also offer competitive low rates, but these rates are only available to highly qualified borrowers with excellent credit scores.

Some final tips on smart loan repayment….

  1. Just because a college offers various types of loans as part of your package does not mean you have to accept them. The type (and amount) of loans that you accept is your choice.
  2. Borrow only what you need. This may seem like a no-brainer, but make sure the loan money disbursed to you is only being used for education related costs and basic living expenses.
  3. For loans that accrue interest while you are in school (unsubsidized and private loans), consider making payments on your student loans while in college instead of deferring them until you graduate. This way, you can cut down on the amount of payments you make on the loan (and save yourself money in interest on those payments).
  4. If you do wait until after college to repay your loans, consider paying more than the minimum monthly payment if you can afford it. This will help pay down your loans faster and save you money in interest over time.
  5. If you have to finance a large sum of money, make sure that you will be able to handle the average monthly loan payment on a typical entry level salary for the career you are interested in. You can find salary information for a variety of jobs here. You may find that a $200/month payment is doable, but a $400/month payment will cripple your budget.
  6. It’s never too late to start saving. Whether you are a high school freshman or a college senior, putting money away now (even a small amount) will give you increased flexibility when it comes to paying down debt.

While the world of financial aid can be confusing, you have a range of different options when it comes to affording and financing college. Your education is one of the most important investments you will make, and wise loan repayment choices now will benefit you immensely in the long run.

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