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When paying for a post secondary education, scholarships, grants, and financial aid may not be enough to cover the total expenses associated with going to school. As a result, loans may become the only way that a student or their family can imagine making their dream school or program a reality. For students and families who qualify for federal funding, two of the most commonly borrowed loans that are awarded as financial aid are federal subsidized and unsubsidized loans. Both of these loans can be used to cover the expenses accrued during an education at a 4-year university, a community college, and a trade or technical school. However, the substantial difference in both the subsidized and unsubsidized loans is the amount that the federal government is willing to administer to qualifying students in a given academic year and the total principal amount that the student will have to repay once they graduate. Overall, the distinctions and availability of both a subsidized and unsubsidized loan will make a considerable difference in the amount of time and money the student or family repays over time to the federal government for investing their education.

Subsidized vs. Unsubsidized Loans

Simply put, the main difference between the subsidized and unsubsidized loans are the terms outlined for each respective loan. For a Direct subsidized loan, your school or university determines how much the student or family is allowed to borrow and the loan amount cannot exceed the calculated financial need. Moreover, the subsidized loan is only available for an undergraduate degree. The reason this loan is referred to as a “subsidized loan” is because the U.S. Department of Education pays the interest of the loan:

  • While the student is in school at least half-time
  • During a grace period (known as the first six months after the student leaves school)
  • During a deferment period (know as a postponement of loan payments)

As a result, the student or their families does not have to worry about paying back the principal balance or paying interest until after a grace or deferment period.

Conversely, the federal government does not cover an unsubsidized loan’s interest rate, and interest starts to accrue as soon as funds are disbursed. The Direct unsubsidized loan is available to both undergraduate and graduate students regardless of financial need. The school or university still determines the amount that can be borrowed depending on the cost of attendance and other financial aid that the student receives. However, the borrower is responsible for paying the interest at all times even while in school, during a grace and deferment period, and during forbearance periods. If the borrower fails to pay the interest, it starts to accrue (add up) and it is capitalized (added to the principal loan balance). Hence, unknowing borrowers might be surprised to discover a higher principal balance from their original loan amount after graduating. One method commonly used to minimize the capitalization of interest is to start paying of interest as it is added while in college.

Requirements and Factors that Affect Eligibility for Loans

Regardless of these distinctions, both subsidized and unsubsidized loans include an interest rate that effects the amount that the student is expected to pay back either in monthly payments or the total principal balance. In order to initially apply for a federal loan, the family and student must fill out the Free Application for Federal Student Aid (FAFSA). With the FAFSA, and other required documents as required by school, the school determines the amount of financial aid that is given to the student and sets limits on the amount that the student is allowed to take out in loans. For either types of loans, the way that students file their taxes (either as dependents or independents) heavily influences the amount they can take out during their undergraduate career with independent students having a larger cumulative limit during their education. Additionally, graduate or professional students may also borrow up to $20,500 per year or $138,500 total in unsubsidized loans since these type of loans do not depend on need or a family’s wealth. As for the interest rates for these loans, both subsidized and unsubsidized loans have a fixed interest rate of 4.29% for an undergraduate degree and a 5.84% fixed interest rate for direct unsubsidized loans for a graduate or professional degree.

Thinking About Loan Repayment

As for loan repayment, both types of loans have a typical repayment period of 10 years with monthly repayments factoring in the principal amount borrowed, the interest rate, and a 1% origination fee. In an effort to make loan repayment plans affordable, most loan repayment plans can be placed in a Standard Repayment Plan with fixed monthly payments of $50 over 10 years or offer other repayment solutions for students with varying financial circumstances in order to avoid default. Moreover, both types of loans give students a grace period where student and families do not have to start making payments until 6 months after they graduate. Under certain circumstances, both types of loans have the option of entering into a period of deferment where there is a postponement of payments. However, in both a grace period and deferment, unsubsidized loans accrue interest and will ultimately affect the principal balance. The type of loan that a family or student chooses could greatly affect their ability to easily repay the loan over a lifetime.

Ultimately, a loan typically serves as a last resort for many students and families looking to pay for their higher education. For all borrowers, it is recommended to borrow only what is necessary and to exhaust as many alternative options of funding as possible while avoiding private student loans. After college, a loan typically follows the borrower for several years, as it becomes the responsibility of the borrower to pay back the loan regardless if they finished their education or cannot find employment after graduation.

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