With college becoming increasingly expensive, students are taking out federal loans (subsidized or unsubsidized) to fund their programs of study. The Department of Education provides these loans, and borrowers are required to pay them back after graduation. As of 2019, the total outstanding student loan debt was $1.5 trillion.
Because Federal Loans are the primary way through which students can afford a college education, it’s important to understand how they work. Indeed, taking out a subsidized vs. unsubsidized loan may result in significant differences in the amount of interest that accumulates over time. And because of how expensive college has become, the interest on student loans can add up to thousands of dollars.
Understanding Direct Federal Loans
There are 2 main types of Federal Loans for college students, subsidized and unsubsidized. A subsidized loan is one that doesn’t accrue any interest until you begin to repay. This means that from the time you take out the loan to the time you graduate, the federal government will pay for any accrued interest on your behalf. Subsidized loans are given based on financial need, and students must be enrolled at least part-time.
The other type of Federal Loan for students is unsubsidized loans. This financing option begins to accrue interest immediately after the funds are disbursed. However, you don’t have to pay the interest immediately. The accrued interest (which will have accumulated while you’re in college) will be added to the original amount you received (the principal).
For most students, subsidized loans are a lucrative option because the total amount of interest they have to pay is lower. But there’s more that goes into each type of loan, and you may find that one option works better for you than the other.
What is a Direct Subsidized Loan?
A Direct Subsidized Loan is a type of Federal Loan provided to college students who have financial need. This funding option allows needy students to access a loan that doesn’t accrue interest until after graduation. How does it work? The Department of Education will typically pay for any interest that accumulates on your loan until you graduate.
Upon completion of your program, you’ll have a grace period of 6 months to begin paying your loan plus interest. This means that interest will only begin to accrue after graduation plus 6 months.
Subsidized loans help needy students save thousands of dollars in interest. Indeed, by keeping the principal interest free for 4+ years, you’ll be able to save significantly on your total student debt. You can also enjoy this interest benefit when you put your loan in deferment (or forbearance) for a specific period.
Only undergraduate students who have a financial need are eligible for subsidized loans. Furthermore, you’ll have to be enrolled at least part-time for each semester that you receive federal funding. For all Direct Federal Loans, interest will begin to accrue as soon as you take out the funds. However, the government pays interest on behalf of all students receiving subsidized loans (for the duration of their course). This means that if you take out a $15,000 loan, the amount you’ll need to repay will still be $15,000 upon graduation.
Your school partly determines eligibility for subsidized loans. In addition, the total amount you’re eligible for will be directly related to your level of financial need (and it cannot exceed this need). You should also be aware of the maximum limits that are put in place for subsidized loans. First-year students can borrow a maximum amount of $3500 in subsidized loans. This amount increases to $4500 for the 2nd year, and $5500 for the 3rd year and beyond.
As an undergraduate student, you can borrow a maximum of $23,000 in subsidized loans. The same 150% rule (from unsubsidized loans) also applies to subsidized loans, meaning that students enrolled in a 4-year program can receive federal funding for a total of 6 years. Those enrolled in a 2-year course can receive funding for 4 years.
When you apply for Federal Student Loans (by filling out a FAFSA), your school will first determine how much in student aid you can receive. The Department of Education will then prepare a package according to how much you qualify for from each type of loan.
Understanding How Interest Works on Subsidized Loans
Students who are eligible for subsidized loans can save on total accrued interest (especially when they’re still in school). At the current annual rate of 5%, you won’t have to worry about paying any interest until after graduation (plus a 6-month grace period). This option gives borrowers a huge relief when they start reducing their student loan debt.
Benefits of Subsidized Loans
Perhaps the most significant benefit of subsidized funding is that you’ll end up saving on interest. Such savings can quickly amount to several thousand dollars during your program. You also have more time to plan a repayment strategy for your outstanding loan amount.
For students who decide to put their loan in deferment or forbearance, the government may continue to pay interest on your behalf during this time. In a nutshell, subsidized loans give needy students some leeway to fund their college education without accumulating a significant amount of debt.
The main drawback with this option is funding eligibility. Only undergraduate students with financial need can qualify, and there are limitations as to how much can be borrowed (and what it can be used for). In fact, there are some situations where you may have to pay the interest that has accrued during your course of study. These circumstances include:
- You were no longer eligible for a Direct Subsidized Loan, and you remained enrolled in your current program.
- You fell out of eligibility for a Direct Subsidized Loan, didn’t graduate from your original program, and you decided to enroll in a new undergraduate program (of similar or shorter length).
- You transfer to a new program for which you’ve already exceeded the maximum eligibility period for subsidized loans.
In the 3 scenarios mentioned above, you may end up having to pay the accrued interest from your original loan (which will have accumulated during your course of study). The interest will be added onto your principal.
What is a Direct Unsubsidized Loan?
A Direct Unsubsidized Loan is a type of Federal Loan that students can take out to fund their college education. While this loan option doesn’t require you to demonstrate financial need, interest begins to accrue from the date your funds are disbursed. This means that if you take out the loan as a freshman, you may end up with a few thousand dollars in interest by the time you graduate.
The good news is that you’re not required to pay the interest while still in school. If you don’t make any payments, the accrued interest is added onto your principal upon graduation. And because these loans aren’t based on financial need, you’ll be responsible for paying back the entire amount including principal plus accrued interest.
One of the most significant benefits of Direct Unsubsidized Loans is that they’re available to a broader population of students. Both undergraduate and graduate students can access this funding option for their studies.
Eligibility and How You Can Borrow
Direct Unsubsidized Loans are available to undergraduate, graduate, and professional degree students. Eligibility is based on enrollment of at least halftime during each semester that you’ll receive funding, as well as being in a school that participates in the Federal Direct Loan Program.
You must submit the Free Application for Federal Student Aid (FAFSA) form when applying for either a subsidized or unsubsidized loan. This form will determine how much you qualify for, based on your current school expenses.
You can also be eligible for higher loan limits with Direct Unsubsidized Loans. For example, independent undergraduate students can borrow a maximum of $57,500 in Federal Student Loans for the entire duration of their program. From this amount, a maximum of $23,000 can come from subsidized loans. Graduate students can borrow a maximum of $20,500 per year in unsubsidized loans.
You should also be aware of the eligibility limits that are put in place for unsubsidized loans. The maximum eligibility period for a Direct Unsubsidized Loan is 150% of the length of your program. This means that you’ll remain eligible for up to 6 years for a 4-year course, and 4 years for a 2-year program.
Upon borrowing, you’ll be charged an initial loan disbursement fee of 1.062%, and the loan will be included as part of your financial aid package. You will also be required to sign a loan contract (a promissory note). This document stipulates that you agree to the terms of your unsubsidized loan.
Direct Federal Loans are typically disbursed to your school to satisfy tuition and board expenses, after which the excess amount is returned to you.
How Interest Accrues on Unsubsidized Loans
The interest for unsubsidized loans begins to accrue as soon as your loan is disbursed. This means that students should be prepared to tackle a higher interest amount upon graduation. The Federal Loan interest rate is currently at 5% for undergraduate students, and 6.6% for graduate students. The good news is that interest rates are fixed for the duration of the loan. And while there’s no specific period within which you’re required to begin repaying, interest will continue to accrue as time goes by.
One of the biggest challenges with unsubsidized loans is interest. While you have lots of time to repay, the accrued interest may significantly increase your total loan balance.
Let’s say you initially borrowed $20,000 as a freshman in college. At the current interest rate of 5%, you’ll owe a total of $22,108 after 4 years (assuming that you don’t make any payments until you graduate from a 4-year course). This accrued interest amount is added onto the principal of your loan. Accrued interest is what makes unsubsidized loans challenging for students.
Is an Unsubsidized Loan the Right Option for You?
Despite the interest dilemma, unsubsidized loans have several benefits. They provide access to funding for a wide range of students and make college accessible. Indeed, millions of undergraduate, graduate and professional students can access the education they need because of unsubsidized loans. You will also have lots of flexibility in how you choose to repay.
If you don’t qualify for a subsidized loan but still need funding for college, unsubsidized loans may be the best available option. Students taking unsubsidized loans should keep track of their interest rates and develop a plan for repayment sooner rather than later.
Developing a Plan for Repayment
Most students receive a financial package that consists of both subsidized and unsubsidized loans. If you’re wondering how you can begin repaying what you borrowed, it’s a good idea to start with unsubsidized loans first. This is because you can reduce the principal amount faster, which will also reduce the amount of interest that will compound over time. With subsidized loans, you’ll have more time to enjoy lower interest amounts before they begin accumulating.
How Iron Fist Legal Can Help With Your Student Loans
Are you struggling to repay your student debt? If you owe over $30,000 in student loans, the experts at Iron Fist Legal can help you reduce your outstanding amount by as much as 30-70%.
Many borrowers are charged unreasonably high interest rates on their loans. This problem is compounded when your loans have remained unpaid for long periods of time. Our attorney-based modification strategy allows you to renegotiate what you owe. That way, you pay monthly installments that fit your current budget.
But how is this possible? We negotiate directly with your lender to help reduce the outstanding loan balance to something reasonable. Our team and network of attorneys know the ins and outs of navigating student loan debt, interest rates, repayment plans, and much more. By consulting us, we can help you significantly knock down what you owe.
Are you ready to get relief from suffocating student loan debt? Contact us today.