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If you’ve taken advantage of all the scholarships, grants and other aid available to you and will still have to borrow to go to college, you’ve probably heard that federal student loans are the best place to start.

But did you know there are four types of federal direct loans?

This article, the first in a three-part series, will summarize the ins and outs of one type of loan — federal direct subsidized loans — and explain why, if you must borrow for college, they are the best deal around.

Since not everyone will qualify for a subsidized loan, and because there are annual and lifetime limits on how much you can borrow, we’ll also talk about other types of loans you can fall back on.

Let’s begin by getting a handle on what exactly a direct subsidized student loan is, and how it’s different from other loans you might turn to.

The first thing you’ll notice looking at the chart below is that direct subsidized loans and direct unsubsidized loans offer the lowest interest rate of all federal loans.

Loan TypeBorrower TypeDisbursed on or after 7/1/17 and before 7/1/18Disbursed on or after 7/1/16 and before 7/1/17Disbursed on or after 7/1/15 and before 7/1/16
Direct Subsidized LoansUndergraduate4.45%3.76%4.29%
Direct Unsubsidized LoansUndergraduate4.45%3.76%4.29%
Direct Unsubsidized LoansGraduate or Professional6.0%5.31%5.84%
Direct PLUS LoansParent and Graduate or Professional7.0%6.31%6.84%

The primary advantage of a direct subsidized loan over an unsubsidized loan is that the Department of Education will pay the interest on your subsidized loan:

  • While you’re in school at least half-time.
  • During the grace period of your loan (the first six months after you leave school, when you do not have to begin repayment immediately).
  • If you apply for and are granted a deferment (a postponement of repayment).

The idea behind the grace period is to give you time to find a job that will allow you to begin making your monthly payments, so that you don’t have to stress out while you’re still in school.

If the grace period turns out to not be long enough and you need more time to find a job, you can also apply for deferment. During the deferment period, you will not be responsible for making any loan payments and interest will not accrue. If you need to apply for forbearance, however, you will be on the hook for interest (see “Don’t disqualify yourself from refinancing student loans,” for more detail on deferment and forbearance, and how both can help you avoid delinquency and default.)

Eligibility

In order to qualify for a direct subsidized loan, you must apply for financial aid through your school by filling out the Free Application for Federal Student Aid (FAFSA), and prove your eligibility. To be eligible for a subsidized loan, you must:

  • Be an undergraduate student.
  • Be able to prove financial need.
  • Be enrolled at a school at least half-time.
  • Be enrolled in a program that can lead to a degree or certificate awarded by the school.

How you qualify for need-based financial aid

Let’s talk about how colleges decide whether you qualify for need-based aid, making you eligible for a subsidized direct loan and other assistance like Pell grants and federal work study.

In short, you qualify for need-based aid if your expected family contribution won’t cover your cost of attendance at a particular school.

Your expected family contribution is not necessarily the amount of your family will actually have to pay for college — it’s an index calculated using information you submit on your Free Application for Federal Student Aid (FAFSA). Your cost of attendance includes tuition and fees, room and board, books and supplies, and other eligible expenses.

So if your cost of attendance is $16,000 and your expected family contribution is $11,000, you’re eligible for up to $5,000 in need-based aid.

The other factor limiting how much of your college costs you can cover with subsidized direct loans are annual and aggregate limits for both subsidized and unsubsidized direct loans.

As a freshman, you can take out no more than $3,500 in subsidized direct loans. While the amount gradually scales up to $5,500 a year for juniors and seniors, the lifetime limit on subsidized direct loans for undergraduates is $23,000.

YearDependent StudentsIndependent students (and dependent students whose parents can’t obtain PLUS Loans)
First-year undergraduate annual loan limit$5,500 (maximum of $3,500 in subsidized loans)$9,500 (maximum of $3,500 of in subsidized loans)
Second-year undergraduate annual loan limit$6,500 (maximum of $4,500 in subsidized loans)$10,500 (maximum of $4,500 in subsidized loans)
Third-year and beyond undergraduate annual loan limit$7,500 (maximum of $5,500 in subsidized loans)$12,500 (maximum of $5,500 in subsidized loans)
Graduate or professional students annual loan limitNot applicable (grad students are considered independent)$20,500 (unsubsidized only)
Subsidized and unsubsidized aggregate loan limit$31,000 (maximum of $23,000 in subsidized loans)$57,500 for undergraduates (maximum of $23,000 in subsidized loans)
$138,500 for graduate or professional students (maximum of $65,500 in subsidized loans). Graduate aggregate limit includes all federal loans received for undergraduate study.

After you’ve maxed out your subsidized direct loan borrowing, financial aid advisers typically recommend that you turn to unsubsidized direct loans to cover additional expenses (unsubsidized direct loans are covered in Part 2 of this series, “Hidden costs of federal direct unsubsidized student loans“).

As the chart above demonstrates, students who are independent of their parents (at least 24 years old, married, or working on a master’s degree, for example) have more leeway to take out unsubsidized direct loans. The same is true of dependent students whose parents can’t take out PLUS loans.

Note that while the lifetime borrowing limits for graduate students are higher, grad students aren’t eligible for subsidized direct loans. Rates on unsubsidized direct loans for graduate students are higher than rates for undergraduates, although not quite as high as PLUS loans. Perkins loans were once an option for graduate students who could demonstrate “exceptional financial need,” but that program is being wound down.

Also keep in mind that for borrowers who took out their first student loan after July 1, 2013, there’s a limit on how long you can receive subsidized direct loans. This eligibility window is equal to 150 percent of the time that you need to complete your degree. So if you’re shooting for a four-year bachelor’s degree, you can take out subsidized direct loans for no longer than six years. For a two-year associates degree, the eligibility window stays open for three years.

Once the eligibility window closes, interest will start accruing on your older subsidized direct loans. If you transfer from a four-year program to a two-year program after having received subsidized direct loans for three years, your eligibility window will close and interest will start accumulating on your loans.

What happens if you’ve taken out all the subsidized and unsubsidized federal direct loans you qualify for? The next step on the federal student loan ladder are PLUS loans, which are available to parents and graduate students.

Although the federal government is still the lender, PLUS loans share some characteristics with private loans — they involve some limited underwriting, sometimes require a cosigner (or “endorser”), and carry higher rates than subsidized and unsubsidized federal direct loans.

In Part 3 of this series, “How and when to use private student loans to fill college funding gaps,” we’ll compare rates and features of PLUS loans with private loans. For many borrowers, private loans can be quite competitive with PLUS loans.

Ariha Setalvad <ariha@credible.com> is a Credible staff writer. Follow us on Twitter at @Credible.

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