Subsidized vs Unsubsidized Loans: Which Is Best To Borrow?

Posted on March 25, 2021 in Loans

The average cost of college in the United States is a staggering $35,720 per student per year. The cost has tripled in the last 20 years and is currently facing an annual growth rate of 6.8%. The average in-state student attending a public 4-year institution will spend $25,615 for only one academic year. The average cost of in-state tuition alone is $9,580 with out-of-state tuition ballooning to an average of $27,437. 

It’s safe to say that anyone looking to attend college will require some serious help financially. While there are many different loans available to anyone looking to borrow money, students have other options. These come in the form of subsidized and unsubsidized loans. The difference between the two will affect how much money is saved when paying them back, so it’s important to know how each one is defined.

What Is A Subsidized Loan?

A subsidized loan is a loan designed for undergraduate students with financial needs, as determined by the cost of their attendance minus expected family contribution and other financial aid such as grants and scholarships. A subsidized loan will not accrue interest while the student is in school, at least in a half-time role or during deferment periods. 

First-time borrowers taking out a Direct subsidized loan are subject to the 150% Direct Subsidized Loan Limit, which caps the amount of time a student is eligible to borrow subsidized loans to 150% of their published program length. For example, this would mean that anyone. This means that tuition for a four year program can only be borrowed for six years. Once this time limit is reached, the applicant will no longer be eligible to receive additional Direct subsidized loans, and the outstanding loans will begin to accrue interest. 

  • What Are The Financial Qualifications? The applicant must demonstrate financial need.
  • How Much Is Available To Borrow: $3,500-$5,500 for first-year students, $4,500-$6,500 for sophomores, $5,500-$7,500 for juniors and seniors. The total maximum allowed is $31,000.
  • When Does Interest Start To Accrue: It begins to accrue immediately but is paid for by the Education Department while the student is enrolled in school.
  • What Is The Interest Rate: 2.75%
  • Who Is Eligible: Undergraduate students only
  • When Do Payments Start: Repayment begins six months after leaving college, must be made monthly, and must be repaid within 10 years

What Is An Unsubsidized Loan?

An unsubsidized loan is intended for both undergraduate and graduate students and is not based on financial need. The eligibility will be determined on the cost of attendance minus other financial aids such as grants or scholarships. Interest will be charged while the student is in school, while also during deferment and grace periods. Contrary to subsidized loans, the student will be responsible for the interest from the time the unsubsidized loan is disbursed and all the way until it is paid back in full. The student may choose to pay the interest or allow it to accrue and be capitalized (added to the principal amount of the loan). Capitalizing the interest will increase the amount that will have to be repaid. 

  • What Are The Financial Qualifications: No need to demonstrate financial need
  • How Much Is Available To Borrow: $9,500 for first-year students, $10,500 for sophomores, $12,500 for juniors and seniors, $20,500 for graduate students. The total maximum allowed is $57,500.
  • When Does Interest Accrue: As soon as funds are exchanged.
  • What Is The Interest Rate: 2.75% for undergraduates, 4.3% for graduates 
  • Who Is Eligible: Undergraduate and graduate students
  • When Do Payments Start: Repayment can begin as soon as the money is exchanged

Additional Eligibility Requirements For Subsidized And Unsubsidized Loans

There are more eligibility requirements for subsidized loans than there are for unsubsidized loans, such as providing proof of financial needs, but both have a few of the same requirements. Some of them include:

  • Must be a United States citizen, national or permanent resident
  • Must be enrolled in school at least at a half-time rate
  • Must not have defaulted or owed a refund to any previous aid programs
  • Must maintain satisfactory academic progress

Which Loan Is Better?

Clearly, a subsidized loan will be the best option available to any student that meets the qualifications, but realistically it will take a combination of both in order to cover the costs of a college education. The benefits of subsidized loans, interest deferment especially, will make it the preferred choice. 

However, these subsidized loans come with a lot of restrictions, and the borrowing cap will mean other loans will be required. The best option would be to use unsubsidized loans to cover the remaining costs, but if this is still not enough, then there are private student loans available. 

Private Student Loans

From a financial perspective, the best idea for paying college tuition is to utilize subsidized and unsubsidized loans as much as possible. In the event that this is still not enough to cover the price of college, there are other student loans available. However, there are a lot more drawbacks to private student loans than federal student loans, so be sure to get as many federal loans as possible to cover costs. Some of the drawbacks include:

  • Private loans are harder to get. Almost all private student loans are based on credit. This means the applicant must show a positive credit history and adequate income in order to qualify or have a co-signer who can assume the risk of the loan.

  • Interest rates are higher for private loans. The current interest rate for federal student loans is fixed at 2.75%. For private loans, the interest rates will be significantly higher. Interest rates for private student loans can range from around 3.39% to 14.5%, with an average of 7.64%. While federal student loans will come with an origination fee of 1.057%, private loans’ interest rate will more than dwarf that cost. The interest on private student loans will also begin to accrue immediately and does not stop until repayment.

  • Private loans are more strict on repayment. In the case of federal student loans, federal debt collectors will have the option to bypass courts and directly seize tax refunds or perform wage garnishment, but private student loans offer less wiggle room on repayment.

    Federal student loans offer broad ranges of deferral and forbearance options that can pause payments and even reduce them. Federal borrowers are able to apply for economic hardship, which can defer repayment for up to three years. Private lenders are much less likely to offer programs such as these.

  • Private loans are not included in most forgiveness programs. Federal Public Service Loan Forgiveness and income-driven repayment plans will require federal loan borrowers to make a set number of payments before forgiving the loan’s remaining balance. Private student loans offer no such options and expect the balance to be paid in full.

  • Defaulting on private loans has more consequences. A federal student loan will enter default after 270 days of nonpayment. Even after this occurs, federal borrowers will still have options to restore their good standing. Private loans are typically placed in default 30 days after a payment is missed, and lenders may charge off the loan in as little as 120 days.

The Takeaway

When it comes to answering which loan is better between subsidized and unsubsidized, the answer will be subsidized. The deferment of interest rate can save a lot of money for the borrower, and for that reason, alone is the superior option. Unsubsidized loans may not be the very best option, but they should be the next option selected when compared to private student loans. 

Federal student loans may have several issues and could be managed better, but they are still the best option available to anyone wishing to pay for college. Private loans can be much more of a risky endeavor and should only be considered when all federal options have been exhausted. While there are some private loans that are better than others, ultimately, the first step should be federal funding.

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