Undergraduate and graduate students who need money to pay for school can apply for federal students loans after submitting a Free Application for Federal Student Aid (FAFSA). But once your school sends you an award letter, you’ll need to figure out which student loans to accept.
The U.S. Department of Education issues several types of federal student loans through the William D. Ford Federal Direct Loan Program, or simply the direct loan program. Two of these are direct subsidized loans and direct unsubsidized student loans.
Direct subsidized loans are only available to eligible undergraduate, community college, trade, career or technical school students, while direct unsubsidized student loans may be offered to graduate students as well.
There are also several other types of direct loans:
- Direct PLUS loans for graduate or professional students, also known as grad PLUS loans
- Direct PLUS loans for parents of undergraduates, also known as parent PLUS loans
- Students who have previously taken out federal student loans may be able to combine their loans with a direct consolidation loan.
We’re going to delve into direct subsidized and direct unsubsidized student loans, the differences between the two and when one type of loan may be better than the other.
What is a direct subsidized loan?
Direct subsidized loans are federal student loans for undergraduate students. There’s no credit or minimum income requirement to borrow a direct subsidized loan, but the loans are need-based, and your school’s official cost of attendance (COA) and your expected family contribution (EFC) will impact your eligibility for direct subsidized loans.
Direct subsidized loans also have a $23,000 aggregate loan limit along with annual loan limits:
- $3,500 for your first year
- $4,500 for your second year
- $5,500 for your third and subsequent year
Your school will determine your loan offer. At most, you may be offered direct subsidized loans for the greater of your annual loan limit or your financial need amount, which is the difference between your COA and EFC.
Since your COA and EFC may change from one year to the next, your eligibility for direct subsidized loans and your loan offer amount may also vary.
You also can’t borrow direct subsidized loans for longer than one-and-a-half times your programs length. For example, if you’re in a two-year associate degree program you can only take out direct subsidized loans for up to three years. If you later switch to a four-year bachelor’s degree program, your timeline increases to six years, but the direct subsidized loans you previously took out still count against that limit.
What is a direct unsubsidized loan?
Like with direct subsidized loans, there’s no credit or minimum income requirement for direct unsubsidized student loans. Unlike direct subsidized loans, they aren’t need-based, and you may be able to borrow an unsubsidized loan even if you don’t have financial need. However, your school still determines your loan offer amount, which may depend on your COA and EFC.
The loan limits for direct unsubsidized loans are different for dependent and independent undergraduate students, and for graduate students. A dependent student whose parent applies but doesn’t qualify for a parent PLUS loan may also be eligible for an increased annual loan limit.
Annual loan limit
Aggregate loan limit
Dependent undergraduate students
$5,500 for your first year
Independent undergraduate students
$9,500 for your first year
Graduate and professional students
Both subsidized and unsubsidized direct loans require students to maintain at least a half-time schedule at a Title IV school to be eligible. You will also need to meet the basic eligibility requirements and complete and submit a FAFSA each year to remain eligible for any form of federal student loan.
There are also a few differences between subsidized and unsubsidized loans. In addition to the need-based requirement for subsidized loans and the varying loan limits, the primary difference is right in the name — the subsidy.
How does the subsidy work?
With direct subsidized loans, the education department will pay the interest that accrues on your loan while you’re enrolled at least half time in school and during your loan’s grace period (the six months after you leave school).
The department will also pay interest that accrues if you place your loan in deferment and temporarily stop making payments. And, if you consolidate your federal loans and include a subsidized direct loan, the Department of Education will pay a portion of the interest that accrues on your direct consolidation loan if it’s placed in deferment.
There are a few situations when you may lose your interest subsidy, such as if you’re still in school but you’ve exceeded your eligibility period for direct subsidized loans. However, even when this happens, you’ll only lose the subsidy going forward, and you won’t have to repay the interest that was already paid on your behalf.
With a direct unsubsidized loan, the interest will begin to accrue once the loan is disbursed (the money is sent to your school). Because there’s no subsidy, the interest will continue to accumulate if you defer your payments while you’re in school, during a grace period or if you temporarily stop making payments by placing the loan in deferment or forbearance.
Once you begin making payments, the interest will be added to your loan’s principal balance (i.e., the interest will be capitalized). Now, your interest rate will apply to a larger loan balance, and your loan will accumulate more interest each month.
The value of the subsidy
If you borrowed $5,500 during your first term as an undergrad in the 2018-19 school year, you received about $5,441 after paying the disbursement fee. During the following 51 months (45 months at school, plus a six-month grace period), the loan would accrue about $1,168 in interest. (The interest rate for undergraduate loans disbursed for the 2018-19 school year is 5.05%.)
With a subsidized direct loan, your principal balance will be $5,441 at the end of your grace period since the Department of Education pays the interest. But it would be $6,609 if you had an unsubsidized loan, because the interest will accumulate and capitalize.
If you repay the loan using the standard 10-year repayment plan, you’ll pay approximately $6,941 in total for the direct subsidized loan. By contrast, you’ll pay approximately $8,431 in total for a direct unsubsidized loan—a difference of $1,490 for just one year of school.
Rates and fees
For undergraduate students, or students who are enrolled at a community college, trade, career or technical school, the subsidized and unsubsidized loans offer the same interest rate and disbursement fee.
Graduate and professional aren’t eligible for subsidized loans and will receive a higher interest rate on their unsubsidized loans.
Subsidized vs. unsubsidized student loan
For loans disbursed from Oct. 1, 2017, to Sept. 30, 2018: 1.066%
For loans disbursed from Oct. 1, 2018, to Sept. 30, 2019: 1.062%
Oct. 1, 2017-Sept. 30, 2018: 1.066%
Oct. 1, 2018-Sept. 30, 2019: 1.062%
Graduate / professional
Oct. 1, 2017-Sept. 30, 2018: 1.066%
Oct. 1, 2018-Sept. 30, 2019: 1.062%
What about other types of student loans?
In addition to subsidized and unsubsidized direct loans, students may be eligible for grad PLUS loans or private student loans.
Grad PLUS loans are unsubsidized direct PLUS loans for graduate and professional students. Like other federal student loans, they offer the same fixed interest rate to all borrowers, and charge a disbursement fee that’s taken out of the loan disbursement amount. For grad PLUS loans disbursed from July 1, 2018, to June 30, 2019, the interest rate is 7.60%, a full 1 percentage point higher than unsubsidized student loans.
Unlike with subsidized loans, the education department will review borrowers’ credit reports, and you may not be eligible for a grad PLUS loan if you have an adverse credit history. However, your income and credit score won’t affect your eligibility.
Private student loans are available from a variety of lenders, including banks, credit unions, online-only lenders, states and schools. Private student loans are credit-based loans, meaning your credit history, credit score, income, outstanding debts and other factors may be considered when you apply for the loan.
Each lender may set its own eligibility requirements, and the rates and terms you’re offered can depend on the lender as well as your creditworthiness. Lenders may also have different policies that can impact borrowers who have trouble making payments. Because of this, it’s important to compare private student loan lenders and their loan offers.
Private student loans don’t give borrowers access to federal student loan repayment, deferment, forbearance, forgiveness or discharge programs. Because of this, and due to the underwriting requirements that may lead to much higher interest rates than federal student loans, many borrowers are better off with federal student loans.
Which type is right for you?
For undergraduate students who are offered both subsidized and unsubsidized direct loans, starting with a subsidized loan is generally the best option. Although the loan limits are lower than for subsidized loans, the interest rate and disbursement fees are the same and you can save money by avoiding accumulating interest while you’re at school. The subsidy will also help keep your debt from growing if you need to put a loan into deferment in the future.
If you’ve maxed out your subsidized loan limit for the year, in aggregate or due to the time limit, you may still be able to borrow more money with an unsubsidized direct loan. And, if you still have a funding gap, one of your parents may be able to take out a parent PLUS loan or cosign a private student loan for you.
Graduate and professional students
Graduate and professional students aren’t eligible for subsidized loans, but they may be able to take out grad PLUS loans. For these students, the subsidized loans are probably the best option because they have a lower interest rate and disbursement fee than grad PLUS loans.
Students who’ve maxed out their unsubsidized loan limits may then want to turn to grad PLUS loans, which don’t have a preset annual or aggregate loan limit.
Because graduate and professional are more likely to have an established credit history and higher income than undergrads, they may also want to look into different private student loan options. Although private student loans don’t offer as many options to borrowers who have trouble repaying their loans, they may offer you a lower interest rate than federal loans, and generally don’t charge an origination fee.