What is a Subsidized Loan and Why is it Important to College Students?

A Direct subsidized student loan is available only to undergraduate students enrolled in an accredited trade school, career program, community college, or university at least half-time. (Graduate students may be eligible for a Perkins loan, which is also subsidized.)

The interest that accrues on this loan while the borrower is in school (and for six months after they graduate) is paid for by the U.S. Department of Education. When this six-month grace period is over, the borrower must begin making monthly payments of both principal and interest on the loan.

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Eligibility for this type of student loan is based on the borrower’s ability to pay for school, assessed through their individual FAFSA (Free Application for Student Aid) application. The school makes a determination about how much money the student will need for school during the coming year, and then use a series of formulas to decide what portion of those funds will come from grants, subsidized loans, unsubsidized loans, and student contribution.

Subsidized loan limits

Some limits are imposed on students who began using subsidized loans to finance their education on or before July 1, 2013. These borrowers are not eligible to receive subsidized loans for more than 150% of the published program length they are enrolled in. This gives students up to six years to complete most four-year programs that lead to a bachelor’s degree, and three years to complete most two-year associate’s degree programs. Changing programs doesn’t restart the clock, so it’s important to pay attention to the timeline.

The total amount of subsidized loans any one student can receive is limited in a few different ways. Dependent students, independent students, and dependent students whose parents can’t get PLUS loans may be eligible for up to $23,000 in subsidized loans during the time they pursue an undergraduate degree. Graduate students are subject to a $65,600 subsidized loan limit, including subsidized loans accrued during their undergraduate years of study if they began their program before July 1, 2012. Starting July 1, 2012, graduate and professional students are not eligible to receive Direct Subsidized Loans.

Subsidized loan interest rate

Direct subsidized loan rates are set by Congress and are applied to individual loans on the first disbursement date of the loan. This is the date that the funds are available in the student’s account with the school. Although the policies vary according to the financial aid policies at each institution, most schools pay the balance owed on the student’s account, and then after a set period of time they forward the remaining funds directly to the student.

The interest rate changes each year on July 1 for new loans, and then remains unchanged throughout the life of the loan. Students who are, or have been, members of the military could be eligible for different interest rates on both subsidized and unsubsidized federal student loans.

Interest rates on subsidized loans are calculated by taking the outstanding principal balance times the number of days since the last payment times the interest rate factor. To get the interest rate factor, simply divide the loan’s interest rate by 365.

Subsidized loans vs. unsubsidized loans

The difference between subsidized and unsubsidized loans is in how the interest accrues. Borrowers who take out unsubsidized loans to fund their education will pay interest on their loan from the day it is dispersed. Although they are still eligible for the same six-month grace period offered by subsidized loans, the total interest accrued will be more with unsubsidized loans. If the student lets the loan balance sit, without making payments, until after graduation, the unpaid interest is capitalized. That means it is added to the principal balance, which continues to accrue interest. In other words, those borrowers will pay interest on interest.

There is a loan fee that hovers around 1% for both subsidized and unsubsidized loans. The fees are a percentage of the total loan amount and are deducted from the loan disbursement, reducing the amount the borrower receives. The fee does not reduce the amount the borrower must repay, however.

How to apply for subsidized loan

Students can apply for a subsidized loan by accessing the FAFSA at FAFSA.ed.gov. The entire application process, including signing the paperwork and submitting the forms to the school, is available to borrowers online. Returning students will log in with their user name and password to complete a renewal FAFSA for each year they attend classes.

Before beginning the process of applying for a subsidized loan via the FAFSA website, gather tax information for the previous year. Financial award packages, which include grants, work-study programs, subsidized loans, and unsubsidized loans, are need-based and the student’s ability to pay for their tuition, books, and living expenses during the upcoming year are determined by their income from the previous year.

Unmarried prospective students without children of their own who are living with their parents and are classified as a dependent on their parents’ tax return are considered dependent students. In addition to using their own tax information to show income, they also need to use their parents’ tax information to fill out the FAFSA.

Apply as soon after January 1 as possible. Federal student aid is awarded on a first-come, first-served basis. Many applicants wait until their tax returns for the previous year are complete and filed before filling out the application. You don’t have to do this. Estimate the figures to the best of your ability. You can amend them later on. Merit-based aid is also available through the FAFSA, so even families who believe they won’t qualify for any type of need-based aid should fill out the application early to maximize their opportunity to reduce the cost of college.

Paying for subsidized loans

For many people, a federally subsidized loan makes paying for college possible. Without the help of these loans, they may have to put off higher education for years, or even indefinitely. Many programs are available to help tailor the repayment of loans to individual situations. The Pay-as-You-Earn program, extended plan, loan consolidation options, and income-driven repayment plans can lower payments during the first few years of employment after graduation, when the student is just getting started in his or her working life.

Extreme student loan debt is a real problem for many graduates. Making on-time payments until the balance reaches zero is important to the health of the borrower’s credit score and can reinforce other positive debt-handling behavior. Co-signing loans affects the credit score of the applicant and c-signer in different ways, so be sure you understand the risks and benefits before asking anyone to co-sign. Get to know all of the repayment options before deciding which method is best.

Need inspiration on how to tackle your debt? Find out how 5 real grads paid off their student loans.

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