- If you’re an undergraduate student or graduate student who cannot prove financial hardship, consider unsubsidized loans to finance your education.
- There are marked differences between direct subsidized and direct unsubsidized loans.
- For some students, private loans could make more sense. We’ll explore how to figure out whether private loans are a better option for you than unsubsidized loans.
You’re finally off to college (or to a graduate degree program!), and you’re looking into your financing options. You want to make sure you’re making an informed, well-thought-out decision. There are countless terms associated with student loans that you might want to master — things like financial aid, subsidized loans, unsubsidized loans, and deferment.
While researching the various loan options available to you, you likely came across three primary student loan types: subsidized loans, unsubsidized loans, and private loans. In this article, we’re going to cover everything you need to know about unsubsidized loans, taking a look at their pros and cons, and comparing them against the other two primary loan types.
Unsubsidized vs. Subsidized Student Loans
Unsubsidized and subsidized loans are both direct federal loans. Oftentimes, they’re referred to as Stafford Loans or Direct Stafford Loans. Overall, subsidized loans have better terms than unsubsidized loans because they’re designed to help students who have the most financial need, according to the Federal Student Aid office.
Direct subsidized loans are available to undergraduate students who have demonstrated financial need, while direct unsubsidized loans don’t have a financial need requirement, and they’re available to both undergraduate and graduate students. For both loan types, the school determines the amount a student can borrow each academic year. For subsidized loans, this number cannot exceed one’s financial need. For unsubsidized loans, this number is based on the cost of attendance, plus any other financial aid (e.g., salary or wages, family resources) a student receives.
One primary difference between the two loan types is the interest payment schedule. With subsidized loans, the U.S. Department of Education will pay your interest while you’re still in school (at least half-time), for a six-month grace period after you leave school, and while your loans are in deferment, if applicable. With unsubsidized loans, however, you will be required to pay interest during the course of the loan — including while you’re in school.
With subsidized loans, there is a limit, also referred to as a maximum eligibility period, regarding how long you can receive loans. However, there is no eligibility period on unsubsidized loans.
There is a loan limit for both loan types when it comes to the total amount you can actually borrow from the federal government. For example, for first-year undergraduate students, the maximum loan amount is either $5,500 or $9,500, depending on whether the student’s parents have Direct PLUS loans. (No more than $3,500 of this can be in subsidized loans.) For graduate students with unsubsidized loans, the annual loan limit is $20,500.
As of July 1, 2019, the interest rate for direct subsidized and unsubsidized loans for undergraduate students was 4.53%, while the interest rate for direct unsubsidized loans for graduate students was 6.08%.
Unsubsidized Loans and Compound Interest
As we mentioned above, you’re required to pay interest on unsubsidized loans while you’re in school. This means that interest starts accruing the day the loan is funded.
If you’re able to, it’s smart to make student loan interest payments while you’re still in school. This is because of compound interest. When you have a loan that’s accruing interest that doesn’t get paid, that interest is compounded, which means you’re essentially paying interest on top of interest.
Here’s an example of how this works: Let’s say you have an unsubsidized loan balance of $10,000 with an interest rate of 6%. This 6% is converted into a daily rate, which is 0.0164% (6% divided by 365). This daily interest rate is charged on Day 1 of the loan, leaving you with a balance of $10,001.64. On Day 2, your daily interest rate is charged on top of that new balance, and so on and so forth for the life of the loan. By the end of 31 days, your new loan balance will have grown to $10,051.08, and in one year’s time it will be $10,618.31 due to compound interest.
With subsidized loans, on the other hand, your $10,000 will stay $10,000 until you graduate and your six-month grace period or deferment period ends, thanks to the U.S. government.
How to Apply for Unsubsidized Loans
Most students are eligible to receive unsubsidized student loans. Although subsidized loans are typically better, they might not be available to you if you’re an undergraduate student who cannot demonstrate appropriate financial need, or if you’re a graduate student. This is why many students often turn to unsubsidized loans.
If want to apply for a student loan, whether it’s subsidized or unsubsidized, the first step is to fill out the required Free Application for Federal Student Aid (FAFSA). With this form, your school determines your total financial aid package, including how much you’re eligible to borrow.
Unsubsidized Loan Repayment
For unsubsidized loans, the federal government offers favorable repayment plans, most of which are between 10 and 25 years. The Federal Student Aid office provides more details on the various types of repayment plans offered.
You might notice there are income-based repayment plans that sets your repayment amounts as a percentage of your income. These can come in handy when your employment earnings are lower than what’s needed to repay your student loans as scheduled.
However, keep in mind that being on an income-driven repayment plan could cause something called negative amortization in which your interest owed keeps capitalizing (thanks to compound interest) and adding to your loan balance. This can happen because with income-based repayment plans, the monthly payment fluctuates based on your income while the amount you’re paying each month may not even cover the interest due.
Student Loan Discharge and Forgiveness
It’s important to keep in mind that direct unsubsidized loans qualify for loan forgiveness and discharge, though the standards are quite stringent.
You can qualify for student loan discharge due to death or total and permanent disability. “Disability” means you have a medical condition or disability that prevents you from gainful employment and is anticipated to last for 60 months or longer.
Student loan forgiveness is also an option through the Public Service Loan Forgiveness Program (PSLF). You can only qualify if you’re working full-time for a government agency or certain nonprofits; you’re paying your loans using an income-based repayment plan; and you’ve made 120 qualifying payments. In addition, some educators can get student loan forgiveness through the Teacher Loan Forgiveness Program if they’ve taught full-time for five consecutive years at a low-income school or educational service agency, among other requirements.
What About Private Student Loans?
You might be wondering whether it’s advantageous to consider private loans over unsubsidized loans. Although private loans can come with lower interest rates than direct loans from the government, they require credit checks and only those with excellent credit will qualify for the lowest rates.
Another thing to keep in mind is that private students loans aren’t automatically discharged at death like federal student loans are. Private student loan debt could be passed on as a liability to your estate (such as your spouse), or to your co-signer if one was added on the loan.
Private student loans are likely worth considering if you have excellent credit, you’re going into a lucrative field after graduation, such as business or engineering, and you can repay your loans aggressively. It’s also worth considering if you won’t be seeking federal student loan forgiveness through PSLF.
If you pursue private student loans, ensure you’ve improved your credit score, and compare loan offers across various lenders.
Before You Borrow
Before you consider taking out loans of any sort to finance your education, it’s important to tap your other potential sources of funding. After all, why take on debt with a potentially high interest rate if you don’t need to?
Look into grants and scholarships you might qualify for, as well as earnings from work and potential reimbursement from your employer. Consider looking into ways of lowering your cost of attendance, such as living at home for a bit or going to community college before attending a four-year university.
Once you’re in school, keep tabs on your expenses using a simple budget spreadsheet. Maintaining a budget is particularly important if you have unsubsidized loans, especially if you’re able to track your interest payments while in school, eliminating potential surprises upon graduating.
It’s wise to build healthy financial habits while you’re still in school. After all, graduating with less debt sets you up for less financial stress and more potential for success in the future.