When you’re in college, perhaps the only thing more stressful than exams is the ever-present pressure of finances. Paying for college is no walk in the park, especially with the cost of attendance rising to an estimated $21,370 per year for an average four-year public university.
Fortunately there’s one angle of federal financial aid and student loans that are fairly straightforward and often attainable: a direct subsidized loan, or an unsubsidized loan. This form of federal student aid is different than a private loan and has distinct benefits that just might meet your financial needs.
So how do you obtain (and then pay off) subsidized and unsubsidized loans? Here are the pros and cons of these loan types, plus four tips for efficiently paying them off.
What Is a Direct Subsidized Loan?
To understand a subsidized loan, first let’s look at your standard bank loan.
Typical loans have interest rates that go into effect immediately, or after a short grace period. Once the interest starts, interest accrues every single month (or another period determined by the lender) and added to your loan balance. Then, the next period’s interest is calculated on the unpaid loan balance which includes the previous period’s interest, and so on. This is the effect of compound interest, where interest you owe “spawns” more interest and adds to your debt. Depending on the loan amount, interest rate and how often it’s compounded (daily, monthly or annually), this interest can add up to a substantial amount over time.
A direct subsidized loan is a type of federal loan from the U.S. Department of Education and requires you to fill out the free application for federal student aid (FAFSA). What separates a subsidized loan from a private loan is that the interest on a subsidized loan is paid for by the federal government as long as you’re in school. That being said, the government doesn’t pay for the loan itself.
For example, if you take out a $5,500 student loan at the beginning of your first year with today’s interest of 5.05% — that starts accruing immediately and is calculated daily — your loan balance at the end of four years would be $6,732 including the interest that accrued over the past 1,460 days. But with a subsidized loan, the government pays the interest while you’re still in school, thus saving you all that interest that accrued, leaving you with the same balance at graduation of $5,500 from the day you received your loan.
Once your final academic year ends, the interest will then start accruing for you, only you won’t have government assistance paying it. This makes it a great idea to pay down your loan if possible while you’re still in college, as the interest charges you’ll incur after you graduate will be lower.
Pros of a Direct Subsidized Loan
Here are the pros of a direct subsidized loan:
- A subsidized loan doesn’t require any interest payments from you through the length of your program.
- There is generally a six-month grace period after you graduate when your loan doesn’t incur any interest. This gives you time to start making payments before the interest hits.
- Federal direct loans are great for first-time credit users, as they don’t have the same credit requirements as a bank loan.
- You can generally have monthly payments that are far lower than those you’d find with a private loan.
- The federal direct loan programs won’t have the same loan fees a bank or private loan may have.
Cons of a Direct Subsidized Loan
You’re probably wondering if there are any drawbacks to these types of federal student loans. While they’re as close to perfect as most loans get, there are still some drawbacks to federal direct subsidized loans.
- A direct subsidized loan is still a form of debt, an obligation that should be weighed carefully against your future ability to repay.
- Because the U.S. Department of Education pays the interest on these loans, the government applies a financial hardship test that generally needs to be proven in the FAFSA application, and many won’t qualify.
- Graduate students don’t qualify for direct subsidized loans, only undergrads do.
- There are annual loan limits, especially for first-time borrowers, up to $5,500 depending on grade level and dependency status.
- The total amount that can be borrowed increases each year you’re in school, but the borrowing limit is still lower than many private student loans. The overall aggregate loan limit for subsidized loans is $23,000, while private loans can have a far higher cap.
What Is a Direct Unsubsidized Student Loan?
Opposite subsidized loans are direct unsubsidized student loans. This type of loan is fulfilled by the federal government, like the subsidized version, but accrues interest while the student is in college from the time of enrollment until it’s paid off.
This means that same $5,500 loan, if not subsidized by the government, would start gaining interest — daily — while you’re still an active student. By graduation that loan would have grown to $6,732 due to the interest charges that added to the loan which also earned interest over time (how compound interest works). But there’s a little more to these loans than meets the eye.
Pros of a Direct Unsubsidized Loan
Obviously a subsidized loan is more attractive than the unsubsidized version. Still, the unsubsidized version has to have something going for it, right? Here are the pros.
- Unsubsidized loans can be granted to graduate students, not just undergraduate program students.
- The requirements for these loans aren’t as steep, meaning financial hardship doesn’t have to be proven.
- The annual limits are generally higher than subsidized loans, up to $20,500 depending on grade level and dependency status, although the available annual loan amount is reduced by any subsidized amounts received for the same period.
Cons of a Direct Unsubsidized Loan
Despite their higher acceptance rate, there are some drawbacks to these loans.
- Unsubsidized loans gain interest the entire duration of your degree program and until they’re completely paid off.
- The period of time during which these loans gain interest leaves you more vulnerable to graduating with a substantial amount of debt.
The cons list may look shorter than the subsidized loans, but the financial burden these loans can place on you can’t be overstated.
Tips for Tackling Loan Repayment
Unless your parents set aside a nest egg for your college years or you happened to luck into a nice chunk of change, you’re probably among the 60% of graduates who carry some college debt. While it can be daunting at first, there are manageable ways to tackle that debt and reduce the burden, especially if you have the right information. No two cases are the same, but these tips should help just about everyone tackle their student loans and college debt.
1. Tackle Private Loans First, Then Unsubsidized Loans Next
If you have both private and federal student loans, you’re usually better off driving down the balances of private loans first because they typically carry higher interest charges during the life of the loan, as interest is accruing — and compounding — from the get-go. Private loans also have less favorable repayment terms than federal loans which offer loan forgiveness if you qualify. More on loan forgiveness below.
Then, between your unsubsidized and subsidized loans, experts recommend paying your unsubsidized loans first. These will develop higher interest charges over the life of the loan since the interest on these loans start accruing from the date you received the funds.
If you can make payments on your private and unsubsidized loans during your college years, even better. If not, tackle them first thing when you graduate. If your cash flow allows, make extra payments on these loans to drive the balance lower and sooner, to prevent the interest charges from compounding as much as possible.
The subsidized loans will only just start gaining interest six months after you graduate, making them a lower priority.
2. Develop a Repayment Plan
Speak with your financial adviser and the lender(s) to develop a repayment plan. Consider your loan interest rates and determine which loans need to go first.
The loan servicer, the person who handles your loan and billing, can sometimes offer advice or get you in touch with the right people to develop a repayment plan as well. A repayment plan can bundle your payments on the different loans you’ve taken out over the years into one convenient payment that’s automatically deducted from your bank account.
Make sure you clarify any repayment terms here as well, as some loans could have a variable interest rate that changes after a set period of time. You want to make sure you’re not getting penalized while leaving yourself enough money to live on and save.
3. Look Into Loan Forgiveness
If you’ve been struggling to pay off your loans, consider loan forgiveness or pay-as-you-earn programs. This page from the U.S. Department of Education describes the numerous programs and resources the government offers to help reduce the burden of student debt. Only government loans qualify for these programs, however. Borrowers may qualify for reduced payments and loan forgiveness after consistent repayment over 10 to 25 years depending on the program, while those in the teaching, public service, healthcare, nonprofit, or similar sectors may qualify to have their loans forgiven after 10 years.
If all else fails, you may even qualify for a deferment, during which time your loan payments are put on hold for a set period of time. These little breaks can give you the breathing room you need to catch up on your other bills.
But be cautious that while your cash flow may be temporarily relieved of student loan payments, you may still be responsible for the interest payments on your student loans during deferment. Under certain conditions, the interest due could be added to your loan, thereby increasing your loan balance while you’re unable to pay — and that would not be much of a relief in the long-run. So only consider deferment in case of financial hardship.
4. Stay Focused
Most importantly, stay calm and keep focused on driving your debt balance lower each year. Debt can increase anxiety if you let it. Remind yourself that you’re in control, stick to your established plan, and remember that help is always available, both online and with local financial specialists.
Your Academic Career: First Steps to Greatness
Student debt isn’t the most fun thing in the world, but for many it’s almost synonymous with college. An education can take you far in this world, and whether or not you have debt, knowledge is everything.
The takeaway here is that federal student loans are more attractive than private bank loans because they typically carry a lower interest rate and offer more flexible repayment terms, even loan forgiveness, if you qualify. Subsidized federal student loans are the best of all, providing you with a runway while you are still in college since the government pays the interest for you.
You know what options are available to you as a college student, and you know how to begin tackling any debt you may already have. Take things one step at a time.
Before too long you’ll be sitting in a crowd at your graduation, cap on your head and diploma in hand. When it comes time to make payments on your student loans, you’ll be ready.