Financing a college education is daunting for many people. The cost of tuition is constantly rising, with no signs of slowing down. One of the best ways to pay for a higher education is through federal student loans offered by the U.S. Department of Education. These are low-interest loans that are available to eligible students, and are either subsidized or unsubsidized by the government. Each type of loan has different requirements to obtain and different terms for paying it off.
What is a Subsidized Loan Versus An Unsubsidized Loan?
Subsidized and unsubsidized loans help students pay for college or trade or technical school. Students must be enrolled at least half-time at a school that participates in the U.S. Department of Education’s Direct Loan Program, and one that leads to a terminal degree or certificate. The loans are used to cover the cost of tuition, housing and other needed materials, such as books. There are several differences between a subsidized loan and an unsubsidized loan.
Subsidized Loan. A subsidized loan is only available to undergraduate students who have a financial need. Financial need is determined by how much it costs to attend school minus how much that cost you can cover using other sources, such as scholarships or personal funds. The school’s financial aid office determines how much a student can borrow using these factors.
With a subsidized loan, the Department of Education pays interest while the student is in school at least half-time, for the first six months after leaving school and during any postponement of loan payments.
Unsubsidized Loan. An unsubsidized loan is available to all undergraduate and graduate students, regardless of financial need. How much a student can borrow is determined by the school’s financial aid office, and is based on the cost of attendance and other sources of payment.
Unlike a subsidized loan, students must always pay interest on an unsubsidized loan. Students who opt to not pay interest while they are in school or during other periods will have the interested added to the principal amount of their loan. This can result in higher payments in the long-term since the base loan amount increases.
Why You Need a Subsidized Loan
If the costs associated with higher education are more than you anticipate, you want to explore a federal loan. Federal loans are generally lower-interest than private loans, with a more generous pay-off schedule. In certain instances, such as working in the public service sector following graduation, you can even get a federal loan forgiven.
A subsidized loan is the most desirable of the government loans because of its interest deferment. When you are in school and for the six months after graduation, interest does not accrue on your loan. This keeps the principal balance lower and results in less being paid over the lifetime of the loan than one where interest constantly accrues.
Keep in mind that there are annual and lifetime limits on the number of subsidized loans you can receive. As of 2018, that limit ranged from $3,500 to $5,000 annually, with a lifetime limit of $23,000 in subsidized loans per person. If any financial aid is needed over this amount, unsubsidized loans, grants and scholarships may be available.
Paying Off a Subsidized Loan
As with any loan, a subsided loan does need to be repaid. In this case, to the government. You have six months from the time you graduate, leave school or drop below half-time enrollment to start repayment. Loan payments are due monthly, and you typically have 10-to-25 years to repay your loan. The amount of your monthly payment depends on how much you took out, the interest rate and the repayment plan you are on.
The U.S. Department of Education offers the following plans for paying off a subsidized loan:
- Standard Repayment Plan. Payments are fixed each month so that you pay off your loan within 10 years.
- Graduated Repayment Plan. Payments start low and increase every few years, with the goal of paying off your loan with 10 years.
- Extended Repayment Plan. Payments are fixed or graduated to allow you to pay your loan off within 25 years. This is available to Direct Loan borrowers with more than $30,000 in outstanding Direct Loans, including subsidized loans.
- Revised Pay As You Earn Repayment Plan (REPAYE). Monthly payments are based on your family income and are set at 10 percent of discretionary income. This plan allows a loan to be forgiven after 20-or-25 years, depending on whether the loan was for undergraduate or graduate study.
- Pay As You Earn Repayment Plan. This is the same concept as REPAYE, except you will never pay more than you would have under the 10-year Standard Repayment Plan and any outstanding balance is forgiven after 20 years for any type of Direct Loan.
- Income-Based Repayment Plan. Payments are 10-or-15 percent of your discretionary income, depending on when your first loan was received. This plan allows a loan to be forgiven after 20-or-25 years, also depending on when you received your first loan.
- Income-Contingent Repayment Plan. This plan allows you to make a monthly payment that is either 20 percent of your discretionary income or a fixed amount to pay off your loan over 12 years, whichever is less. The outstanding balance on this loan is forgiven after 25 years.
- Income-Sensitive Repayment Plan. This plan allows for monthly payments based on your annual income, with a goal of paying off your loan in 15 years.
While the thought of having your loan forgiven after a certain amount of time is appealing, you may be required to pay income tax on the forgiven amount.