How do subsidized loans work?

Planning for college can be an exciting time in a student’s life. But finding ways to pay for school may seem like a daunting task. If you research ways to pay for college, you’ll probably come across some federal student aid options. 

With nearly 45 million borrowers, federal student loans are a common way to cover ever-rising college costs. Direct Subsidized Loans could offer eligible students some interest-saving perks. 

Learn how subsidized loans work, who may qualify for them and more.

Key takeaways

  • Undergraduate students with financial need could qualify for subsidized loans.
  • The U.S. Department of Education (DOE) pays interest on subsidized loans when students maintain at least part-time enrollment and during certain grace periods or deferments. 
  • Qualifying students can borrow a maximum of $23,000 in subsidized loans for their undergraduate degree, with a $5,500 yearly cap. 
  • Schools use factors like cost of attendance and financial need to determine the subsidized loan amount students can borrow.

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What is a subsidized loan?

A Direct Subsidized Loan is a type of federal student loan that’s offered through the DOE’s William D. Ford Federal Direct Loan Program. According to the DOE, these loans may offer benefits—like fixed interest rates, flexible repayment plans and loan forgiveness programs—that private loans might not. 

And Direct Subsidized Loans could have slightly better interest rates and protections than other student loan options. For example, the way interest applies to subsidized loans could save borrowers money in the long run. That’s because subsidized loans don’t accrue interest during the following situations:

  • When a student maintains at least part-time enrollment
  • During the six-month grace period after the student leaves school or graduates
  • During a deferment period

Subsidized loans offer potential benefits, but keep in mind that they’re only offered to undergraduate students who can demonstrate financial need. 

How do subsidized loans work?

As with all federal student loans, borrowers must fill out the Free Application for Federal Student Aid (FAFSA®) form to apply for a Direct Subsidized Loan. Schools use the information from FAFSA forms along with expected family contributions and other factors to determine the type and amount of aid students can receive. 

If you’re eligible for a Direct Subsidized Loan, you’ll typically see it included in the award letter or financial aid package that your school issues. 

Subsidized loans are one of the four direct loan types offered by the DOE, and each type has its own eligibility requirements and terms. 

Just like private loans, subsidized loans charge interest. But a borrower’s interest rate depends on the loan type and the disbursement date. The current interest rate for a Direct Subsidized Loan is 4.99%, but the rate can change from one year to the next. Once a student receives the loan, though, the interest rate will remain fixed. 

Subsidized loans vs. unsubsidized loans

Federal student loans typically fall into one of two categories: subsidized or unsubsidized. There are key differences between the two. For example, unsubsidized loans are offered to both undergraduate and graduate students. And unsubsidized loans aren’t based on financial need.  

Also, unsubsidized loans accrue interest from the moment of disbursement. Borrowers aren’t typically required to pay unsubsidized interest while they’re in school or during the six-month grace period. But any unpaid interest will be added to the loan’s balance. This could result in increased borrowing costs. But unsubsidized loans have a higher borrowing limit than subsidized loans do, and they offer some of the same protections. 

There are potential pros and cons for every type of federal student loan. You can read more about the differences between subsidized loans and unsubsidized loans to find the best options for your financial situation.

Do subsidized loans have to be repaid?

Borrowers are usually expected to pay back a loan plus interest, and subsidized loans are no exception. If a student graduates, leaves school or drops below part-time enrollment, their subsidized loan will enter repayment. But there’s typically a six-month grace period before that happens. 

Keep in mind that students can start repaying their subsidized loans at any time. Making payments while interest is subsidized could actually reduce some of the student’s borrowing costs. 

If someone is struggling with repayment, they could check their eligibility for loan forgiveness. Programs like one-time federal student loan debt relief and Public Service Loan Forgiveness (PSLF) could help qualified borrowers manage their federal student loan debt.

Who is eligible for a subsidized loan?

Students must meet certain requirements to qualify for any type of federal student aid, including grants, work-study programs and loans. According to the DOE, a student must:

  • be a U.S. citizen or an eligible noncitizen.
  • have a valid Social Security number.
  • be enrolled in an eligible program for the purpose of earning a degree or certificate.
  • meet satisfactory academic progress requirements set by the student’s school.
  • complete the FAFSA and not have loans in default or owe money on grants. 
  • prove they’re qualified to earn a degree by having a high school diploma or General Educational Development (GED) certificate. 

In order to receive Direct Subsidized Loans, students must be enrolled at a school that participates in the Federal Direct Loan Program. In addition to the federal student aid requirements listed above, Direct Subsidized Loans have the following requirements:

  • The student must be an undergraduate.
  • The student must maintain at least part-time enrollment.
  • The student must demonstrate financial need.

Qualifying students can borrow a maximum of $23,000 in subsidized loans over the course of their undergraduate degree. But the student’s school determines how much of that aid they can actually receive.

What is financial need for a subsidized loan?

Students must demonstrate financial need to qualify for a Direct Subsidized Loan. Financial need is determined by the following factors:

  • Cost of attendance: This amount is determined by the school and can include costs like tuition, room and board, textbooks and more. 
  • Expected family contribution: This number is based on information provided in a student’s FAFSA, such as their family’s income and assets and any benefits they receive. 
  • Other financial aid estimate: The school may also consider any additional aid a student receives, including merit scholarships, grants and more. 

A school’s financial aid office will typically add up a student’s expected family contribution and other financial aid estimates and subtract that number from the cost of attendance. The difference is the amount that determines a student’s financial need. 

How much money can you borrow with a subsidized loan?

For subsidized loans, there is a lifetime borrowing cap of $23,000. If a borrower pays down their balance while they’re enrolled, they might be able to borrow more. But they can’t have more than the maximum loan amount outstanding at any time.

There are also caps on how much students can borrow each year.

  • First year: $3,500
  • Second year: $4,500
  • Third year and beyond: $5,500

Who determines how much you can borrow in subsidized loans?

Keep in mind that there are different ways to apply for a student loan, and the loan type often determines the application process. 

Federal student loans, including subsidized loans, require borrowers to complete the FAFSA through the DOE. However, it’s ultimately up to each school’s financial aid office to determine the type and amount of financial aid offered to each student. 

Subsidized loans in a nutshell

Finding ways to pay for college can feel overwhelming, but there are several options to explore. Subsidized loans are one option that could help some college students offset borrowing costs, but not every borrower is eligible for them. 

It’s important to research different financing options and understand how each one could affect your financial future.

If you want to learn more about financially preparing for college, you can read about strategies for paying off student loans.

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