What's the Difference Between Subsidized and Unsubsidized Student Loans?

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You shouldn't need a college degree to figure out how to pay for one. See more college pictures.
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Loans. Grants. Work-study programs. Scholarships. Unsubsidized loans. Subsidized loans. What does it all mean? Sometimes it feels as though you need a college degree to figure out how to pay for college in the first place.

Of course, getting accepted to college is exciting. All kinds of possibilities open up, and the future looks bright. Too often, though, that future tends to dim a little when financial reality hits. Figuring out how to pay for tuition, fees, books, room, board and other expenses can be daunting. Scholarships are great, of course, but not everybody wins one. What's more, scholarships often don't cover all the expenses. Getting some form of federal financial aid is often the way to go.


Many people mistakenly think their family income is too high to qualify for any federal student aid. While much federal student aid is determined by need, navigating the maze of rules and regulations often is worthwhile even for students from relatively well-off families. Unsubsidized loans, especially, can be a good deal for students from families that don't qualify as needy.

Fortunately, Congress has long considered helping Americans gain higher education a worthy goal. Each year, federal student aid helps more than 14 million students pay for college, graduate school or trade school [source: U.S Department of Education]. A good number of those students don't fit the traditional picture of poverty.

Federal student aid comes in three forms: grants, work-study and loans.

  • Grants: Grants are money given to a student for study at an approved school. Grants do not have to be repaid. The best known federal grants are Pell Grants. Grants go to the students with the greatest financial need.
  • Federal Work-Study: The federal work-study program helps students earn money for their education by working part-time jobs. Some jobs are at the student's school. Others are in the community, usually at nonprofits or public agencies. Work-study opportunities are tied to the student's need.
  • Federal Student Loans: Federal student loans must be repaid, with interest, like any other loan. They usually have advantages over the loans that students or their families could get without federal help, however. Some federal student loans are tied to financial need; others are not. There are two major types of federal student loans: subsidized loans, which are tied to need, and unsubsidized loans, which aren't need-based.

Sound complicated? It's not as confusing as it might seem. Read on to learn more about the difference between unsubsidized and subsidized student loans.



Subsidized Loans: Extra Help from Uncle Sam

Unlike a grant, a loan must be paid back. Students typically don't have to start repaying their federal loans while they're in school. But the interest starts mounting from the minute the student receives the loan.

The federal government subsidizes some student loans by giving students breaks on that interest. With subsidized loans, the government pays the interest while the student is in school and any other time the student doesn't have to make payments -- during grace periods and deferments for financial hardship or other reasons. So, a subsidized loan is a better deal than one that's not subsidized.


With unsubsidized loans, the student is responsible for paying the interest from day one, while in school and during any grace or deferment period. Subsidized loans are for students with financial need, and Uncle Sam helps them out further by setting an interest rate that's lower than that of unsubsidized loans.

When it comes to student loans, federal Perkins Loans are a good deal. They are all subsidized. The interest rate is fixed at 5 percent. The federal government pays the interest while the student is in school, during a nine-month grace period after school and during deferments. Perkins Loans are supposed to be paid back in 10 years [source: FinAid].

Why doesn't every student who needs financial aid take out a Perkins Loan? There are limited federal dollars for Perkins Loans, and they go to the students who show the greatest need.

Instead, many students turn to the Stafford Loan program. That's where the two kinds of loans -- subsidized and unsubsidized -- figure into the mix. The subsidized Stafford Loans are based on need. The unsubsidized Stafford Loans are not tied to need. Students usually have between 10 and 25 years to pay either type back [source: U.S Department of Education].

Subsidized Stafford Loans have an interest rate fixed at 5.6 percent for the 2009-10 school year. The rate is expected to be 4.5 percent for the 2010-11 school year [source: Stafford].The federal government pays the interest while the student is in school and during a six-month grace period after school.

For unsubsidized Stafford Loans, the interest rate is fixed at 6.8 percent -- and the student pays it all.

Without Uncle Sam's help paying the interest, are unsubsidized Stafford Loans a good deal? Read on to learn why unsubsidized loans are worth considering.


Unsubsidized Loans: Worth a Look

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Unsubsidized loans can cost you more in the long run, but not as much as a private loan would.
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With college costs high and getting higher, many students need substantial sums of money beyond what their family, work, grants or scholarships provide. If they are unlikely to qualify for need-based loans, or if they need money beyond the limits of subsidized loans, why should they bother to go through the red tape of applying for an unsubsidized federal Stafford Loan? Wouldn't it be easier just to apply for a private loan?

Not really. There are several good reasons for students who need money for their education to borrow as much of it as they can through unsubsidized Stafford Loans. College financial-aid officers usually advise students and their parents to go with fixed-rate unsubsidized Stafford Loans rather than private loans.


The benefits of unsubsidized Stafford loans include:

  • No credit check is required.
  • No collateral is needed.
  • The interest rate, at 6.8 percent now, is usually lower than that on available private loans.
  • The interest rate is fixed, while those of private loans could change at any time.
  • There is no need for a parent or anyone else to co-sign or co-borrow the money.
  • It's usually easier to arrange deferments and flexible repayment plans than it would be with a private loan [source: FinAid].

Those benefits don't come without some work, though. To get an unsubsidized Stafford Loan, just they would to get any subsidized federal student loan or other financial aid, the student and his or her family must fill out the Free Application for Federal Student Aid, commonly known as the FAFSA.

The FAFSA is known for being long and complicated. Jacques Steinberg, an education writer for The New York Times, has described "tackling" the FAFSA as "a notoriously cumbersome process that the government is trying to streamline" [source: New York Times Choice Blog].

Although the FAFSA can be mailed in, the government encourages people to fill it out online. The online application walks you through the process, giving instructions for each question. It also uses "skip-logic" to figure out which questions you need to answer. Applying online also gets you a quicker response.

When applying online, use only the approved, secure sites: www.fafsa.ed.gov or www.FederalStudentAid.ed.gov (where you click on the FAFSA logo). Don't provide information to any other site, especially not to one that asks for a credit card number [source: U.S Department of Education].

If you negotiate the FAFSA and gain approval for a subsidized or unsubsidized student loan, how much money can you expect to get? Read on to find out.


The Bottom Line: How Much Loan Money?

Uncle Sam's pot of money for higher education isn't limitless, and neither is a student's ability to borrow from it. There are limits on loan amounts for each year of school and for a student's entire education. Some people borrow a combination of subsidized and unsubsidized loans; there are limits on the combined total. The FAFSA considers any scholarships, grants and expected family contributions and balances that money against the cost of the school when setting loan amounts.

With Federal Perkins Loans, based on need, undergraduates may be allowed to borrow up to $5,000 a year, with a maximum of $27,000 as an undergraduate. Graduate students may be allowed to borrow up to $8,000 a year, with a cap of $60,000 for undergraduate and graduate loans combined.


When you're dealing with subsidized and unsubsidized federal Stafford Loans, the amount students can borrow varies by year in school. The amount also is dictated by whether a student is considered a dependent or an independent student when filling out the FAFSA. Most traditionally aged college students will be considered dependents, so their parents' finances are included on the FAFSA. Specific conditions such as being older, being a veteran, being married, supporting children and pursuing advanced degrees can qualify a student for independent status so that the parents' income is not included [source: Stafford]. If parents can't take advantage of the federal loan designed for them --the PLUS loans -- then their children are treated as independent students.

Here's how much you can borrow in Stafford Loans:

  • First year in school, dependent student: The maximum is $5,500 for the first year. Only $3,500 can be in subsidized loans.
  • First year in school, independent student: Maximum is $9,500, with only $3,500 in subsidized loans
  • Second year, dependent student: Maximum $6,500; no more than $4,500 in subsidized loans.
  • Second year, independent student: Maximum $10,500; no more than $4,500 in subsidized loans.
  • Third year and beyond, dependent student: Maximum $7,500; no more than $5,500 in subsidized loans.
  • Third year and beyond, independent student: Maximum $12,500; no more than $5,500 in subsidized loans.
  • Graduate and professional-degree students: Maximum $20,500 a year; no more than $8,500 in subsidized loans.

The maximum in total loans allowed at graduation are:

  • Dependent undergraduate student: $31,000. A total of $23,000 can be subsidized.
  • Independent undergraduate student: $57,000, with a total of $23,000 subsidized.
  • Graduate or professional degree student: $138,500, including the total of undergraduate loans. A total of $65,500 can be subsidized [source: StudentAid].

For many students, federal loans, subsidized and/or unsubsidized can make getting an education possible.

Read the next page for a few other things to keep in mind.


Other Types of Loans

Parents with new college graduate.
Parents can take out loans to help with their children's education as well.
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Once you understand the basic difference between subsidized and unsubsidized student loans, you're off to a good start in figuring out the financial aid maze. There are a few other things to keep in mind:

  • Parents can sometimes take out federal loans to help pay for their dependent children's education. The federal loans for parents are called PLUS Loans. They're unsubsidized, meaning that the borrower is responsible for all accrued interest. The PLUS loans carry a higher interest rate than Perkins or Stafford Loans. For the 2010-2011 school year, the interest rate on PLUS loans is fixed at 8.5 percent [source: FinAid]. Parents applying for PLUS loans must pass a credit check. They're not required to file the FAFSA to apply for a PLUS loan.
  • Unsubsidized PLUS loans also are available for students in graduate and professional programs. Those students must file a FAFSA; the school will consider the maximum loan limits they have under the Stafford Loan program.
  • Just to complicate things a bit more, Stafford Loans are divided into two other categories, the Direct Loan program and the Federal Family Education Loan (FFELP) program. The difference is that in the Direct Loan program, you're borrowing directly from the federal government. In the FFELP program, you borrow from a bank. Schools decide which loan program they participate in. Some participate in both. The choice makes little practical difference to the student, except that those borrowing through FFELP must choose a bank, usually from a list of approved lenders [source: StudentAid].
  • Unsubsidized Stafford Loans can be an important part of a student's financial aid package. It's smart, however, to be aware of the interest that's mounting up while a student is in school, and during grace or deferment periods. Some people choose to pay the interest during those times even though they're waiting until they're out of school to start repaying the loan's principal. The amount each month is usually relatively low. Many people choose instead to add the unpaid interest that has been added to the principal when they begin to repay the loan. This process is called capitalization. The original principal plus the accrued interest becomes the new principal amount. Interest is then charged on that new amount. The person who pays back a loan in this way is, in part, paying interest on interest. Over time, a person who capitalizes deferred interest will pay more for his or her loan [source: Stafford].


Lots More Information

Related HowStuffWorks Articles

  • Andriotis, AnnaMaria. "Subsdized Stafford Loan Rates Are Dropping." SmartMoney.http://www.smartmoney.com/Personal-Finance/College-Planning/Subsidized-Stafford-Loan-Rates-Are-Dropping/# (Jan. 30, 2010)
  • Federal Student Aid. "Stafford Loans (FEELs and Direct Loans(sm))http://studentaid.ed.gov/PORTALSWebApp/students/english/studentloans.jsp
  • FinAid. "Education Loan Interest Rates."http://www.finaid.org/loans/scripts/interest.cgi
  • FinAid. "Parent Loans."http://www.finaid.org/loans/parentloan.phtml
  • FinAid. "Student Loans."http://www.finaid.org/loans/studentloan.phtml
  • U.S. Department of Education. "Funding Education Beyond High School: The Guide to Federal Student Aid 2009-10."http://www.FederalStudentAid.ed.gov/guide
  • Lenoir-Rhyne University. "Federal Loans."http://finaid.lr.ued/federal-loans
  • O'Shaughnessy, Lynn. "6 Reasons to File the FAFSA." CBS MoneyWatch.com. http://moneywatch.bnet.com/saving-money/blog/college-solution/6-reasons-to-file-the-fafsa/1413/
  • Kantrowitz, Mark. "FAFSA Q&A: Last of 7 Parts: Answers on the FAFSA and Financial Aid." The New York Times Choice Blog.http://thechoice.blogs.nytimes.com/tag/fafsaq-and-a/
  • Winston-Salem State University. "Federal Stafford Loan, Subsidized and Unsubsidized." http://www.wssu.edu/WSSU/About/Administration/Division+of+Student+Affairs/Financial+Aid/loans
  • Student Loan Network. "Federal Student Loans Overview." http://www.studentloannetwork.com/federal-student-loans/
  • Student Loan Network. "Unsubsidized Stafford Loan." http://www.staffordloan.com/stafford-loan-info/unsubsidized-student-loan.php