If you needed money for college and a stranger walked up to you on the street and asked if you’d rather have a subsidized or an unsubsidized loan, you’d probably say “subsdized,” right?
If so, you’d be correct. As we explored in Part 1 of this 3-part series, federal direct subsidized loans are indeed the best deal for borrowers in town (assuming you’ve taken advantage of all the scholarships, grants and other free aid that’s available to you to pay for college).
But that doesn’t mean federal direct unsubsidized loans are a bad deal. They are still government student loans, and that means they come with low, fixed rates and some valuable borrower benefits.
In fact, direct unsubsidized loans for undergraduates carry the same interest rate as subsidized loans. But that interest starts piling up sooner — one of several hidden costs of direct unsubsidized student loans you should know about (more details below).
As the chart below shows, direct unsubsidized loans for grad students are a bit more expensive than those for undergraduates. But the government loans that you really want to think twice about taking out are PLUS loans (see Part 3, “How and when to use private student loans to fill college funding gaps“).
| Loan Type | Borrower Type | Disbursed on or after 7/1/17 and before 7/1/18 | Disbursed on or after 7/1/16 and before 7/1/17 | Disbursed on or after 7/1/15 and before 7/1/16 |
|---|---|---|---|---|
| Direct Subsidized Loans | Undergraduate | 4.45% | 3.76% | 4.29% |
| Direct Unsubsidized Loans | Undergraduate | 4.45% | 3.76% | 4.29% |
| Direct Unsubsidized Loans | Graduate or Professional | 6.0% | 5.31% | 5.84% |
| Direct PLUS Loans | Parent and Graduate or Professional | 7.0% | 6.31% | 6.84% |
Why take out direct unsubsidized loans?
You may find yourself turning to direct unsubsidized loans for a couple of reasons.
First, subsidized loans are only available to undergraduates who can demonstrate financial need. That determination hinges on the cost of the school you’re attending, and information you provide about your income on the Free Application for Federal Student Aid, or FAFSA (see Part 1, “If you must borrow for college, start with subsidized student loans“).
Second, there are strict limits as to how much you can borrow in subsidized loans. Currently you can take out $3,500 in subsidized loans as a freshman, $4,500 as a sophomore, and $5,500 a year when you’re a junior or senior. If you’re in a four-year degree program, you can tap subsidized loans for six years, but there’s a $23,000 lifetime limit on subsidized direct loans for undergraduates.
| Year | Dependent Students | Independent 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 limit | Not 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. |
As the chart above demonstrates, grad students and students who are independent from their parents (at least 24 years old, married, or active duty military, for example) can take out more unsubsidized direct loans — up to $57,500 — than undergrads who are dependent on their parents, who currently max out at $31,000.
Those higher limits also apply to dependent students whose parents can’t take out PLUS loans on their behalf. All of which means that you should be aware of the features of federal direct unsubsidized loans, because you may need to rely on them pretty heavily.
Subsidized vs unsubsidized student loans
There are some subtle differences between direct subsidized loans and their unsubsidized counterparts that you should keep in mind when borrowing money for college and making plans for repaying those debts.
The biggest difference between subsidized and unsubsidized loans is when interest is charged, and when it’s not.
Although unsubsidized loans to undergraduates carry the same low rate as subsidized loans, interest starts accruing on unsubsidized loans while you’re still in school, as soon as the loan is disbursed.
With both subsidized and unsubsidized loans, you get the same six-month grace period after you leave school before you have to start paying your loans back. But with an unsubsidized loan, any interest that you don’t pay while you’re in school and during your grace period will be “capitalized” — added to the principal amount of your loan — when it’s time to start making monthly payments.
While the government will take care of any interest if you need a deferment on a subsidized loan, interest continues to accrue on unsubsidized loans during a deferment. Interest accrues on both types of loans if you are granted forbearance (for more on the differences between deferment and forbearance, and how both can help you avoid delinquency and default, see “Don’t disqualify yourself from refinancing student loans.”)
Another feature of federal direct unsubsidized student loans to keep in mind as you chart your journey through higher education is that if you’re planning on going to grad school, you’ll pay a higher interest rate. Remember, grad school students aren’t eligible for direct subsidized student loans, no matter how great their financial need.
But direct unsubsidized loans are still a less costly option than federal PLUS loans. If you take out a PLUS loan between July 1, 2016 and June 30, 2017, you’ll pay 6.31 percent interest, and an onerous 4.3 percent up-front disbursement fee. Before doing that, it’s worth taking a look at offers from private student lenders, who provide student loans to undergraduates, graduate students and parents that are priced competitively with PLUS loans (see Part 3, “How and when to use private student loans to fill college funding gaps“).
Repayment strategies
If you have unsubsidized student loans, one thing you can do to make repayment more manageable is to make voluntary payments on the interest they accrue while you’re in school, or in deferment or forbearance. Depending on your loan balance, you may be able to keep interest from accruing by paying just $20, $50 or $100 month.
Once your grace period has expired and interest is accruing on all of your loans, consider allocating more of your financial resources to paying down high-interest loans first. Note that if you choose to combine all of your loans into a federal direct consolidation loan in order to take advantage of an income-driven repayment plan, you won’t be able to implement this strategy. Your federal direct consolidation loan will have a weighted interest rate based on the rates of the loan’s you’ve consolidated.
The only way to lower your interest rate is to refinance your loans with a private lender. Although you’ll lose access to some borrower benefits that come with government loans, such as income-driven repayment plans and potential loan forgiveness, refinancing is an increasingly popular option for those who don’t expect to benefit from loan forgiveness.
Income-driven repayment plans can be a lifesaver for borrowers with enormous student loan balances and modest incomes, particularly if they expect to qualify for loan forgiveness after 10, 20 or 25 years of payments. But for others, stretching out payments over a longer period of time will increase the total amount repaid. If you do qualify for loan forgiveness under an income-driven repayment plan, you may face a large tax bill.
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