Subsidized vs. Unsubsidized Loans

The United States Department of Education (DOE) offers students loans to cover the cost of college or their career school through the William D. Ford Federal Direct Loan Program. Loans through this program are known as “direct” loans, in which the DOE is the lender.

The Two Types of Direct Loans:

There are two types of these “low-interest” loans  – Direct Subsidized and Direct Unsubsidized Loans. Some may also refer to them as Stafford or Direct Stafford Loans. Whether they are subsidized or unsubsidized, both loans are federal student loans. To receive either loan, a borrower must enroll in a program leading to a degree or certificate.

Direct Subsidized Loans are available to undergraduate students demonstrating financial need. The school determines the amount they borrow and may not exceed their financial need.

Direct Unsubsidized Loans are also available to undergraduate and graduate students. However, they do not have to demonstrate financial need. 

“Financial need” is the difference between a college’s cost of attendance (COA) and the student’s expected family contribution (EFC): Financial Need = COA – EFC. In addition, basic eligibility criteria for federal student aid are calculated by years in school, enrollment status, and the cost of attendance at the school they are attending. A borrower will use the “Free Application for Federal Student Aid” (FAFSA) to determine this and apply for both types of direct loans.

The school will then use a borrower’s FAFSA to determine the amount they will receive. Direct Loans are part of this financial aid package. There is no separate application for Direct Unsubsidized and Subsidized Loans. 

What’s the Difference?

The DOE will pay the interest on a Direct Subsidized Loan when a borrower enrolls in school part-time, for the first six months after they leave school (known as the “grace period”), and during a postponement of loan payments (known as a “deferment”). In contrast, borrowers are responsible for paying the interest on a Direct Unsubsidized Loan during all periods.

The school will also determine the type of loans and amount the borrower can receive each academic year. Both (unsubsidized and subsidized) loans limit the amount they are eligible to receive each academic year. These are called annual loan limits. Aggregate loan limits are the total amounts someone may borrow for undergraduate and graduate education. The amount they are eligible to receive could be less than the annual loan limits. However, this depends on their year of schooling and whether they are a dependent or independent student.

A dependent student files for financial aid based on their income and their parents’, while an independent student reports only their information. 

If the total amount borrowed reaches the aggregate loan limit, they are not eligible for other loans. But, if repaid until it is below the aggregate loan limit, they can borrow again. 

Other than interest, there is a loan fee on all Direct Subsidized Loans and Direct Unsubsidized Loans. This fee is a percentage of the loan amount and is deducted from each loan disbursement. “Disbursement” refers to the school paying the student their federal student aid fund – distributing the loan. A borrower must use the entire loan for their education expenses.

If it is their first time receiving a Direct Loan, they must complete entrance counseling, a short course-like tool. The counseling will assist the borrower in understanding how they must repay their loan, and they will have to sign a “Master Promissory Note,” a loan contract where they will agree to the loan terms. 

After receiving their Direct Loan, the borrower’s loan servicer (the company managing the loan) will contact them. Once they graduate, they will have a six-month grace period before starting repayment. The borrower will receive this information from their loan servicer, along with the due date.

Conclusion:

While the names imply vastly different types of loans, subsidized and unsubsidized loans hold more similarities than differences. While the DOE will pay the interest on a Direct Subsidized Loan during school, the six-month grace period after graduation, and deferment, the borrower will need to prove financial need. On an unsubsidized Direct Loan, the borrower will have to pay the interest during all periods but is not required to prove financial need. Regardless of if they are subsidized or unsubsidized, Direct Loans offer benefits including low fixed interest rates, income-based repayment plans, postponement, and cancellation/forgiveness (under certain conditions).