Subsidized vs. unsubsidized student loans: the key differences

The looming end of a pandemic-era hiatus for student loan payments and interest is shining a spotlight on a major difference between two types of debt: subsidized and unsubsidized loans.

Interest accrual is among the main differences between the federal loans – also known as Stafford Loans – that are for the cost of higher education.

Direct subsidized loans are available to students who demonstrate financial need.

They do not accrue interest while a borrower is in school (at least half-time) or during a six-month repayment period after he has left school. The loans also do not accrue interest during deferment, a period when payments are postponed due to unemployment or financial difficulties.

The US Department of Education pays the interest on subsidized loans in these cases.

However, this protection is not available for direct unsubsidized loans, which are available to a wider group of borrowers (including graduate students) and are not based on financial need.

Interest on unsubsidized loans starts accruing immediately and borrowers are responsible for interest cumulatively for all periods – making this debt more expensive than subsidized loans.

In some cases – after a deferment, for example – unpaid interest on unsubsidised loans can ‘capitalise’. When this happens, unpaid interest is added to the loan’s principal balance; future interest is then calculated by the higher principal, thereby increasing future interest payments.

Borrowers can carry both subsidized and unsubsidized loans, which have different loan limits.

About 30.3 million borrowers had subsidized Stafford loans as of March 31, with an average balance of $9,800, according to Education Department data. About 30.7 million people have an unsubsidized loan, with an average balance of about $19,000, according to the Education Department.

(The term Stafford loan is an informal way to refer to direct subsidized loans and direct unsubsidized loans made through the Direct Loan program. It also refers to subsidized or unsubsidized federal Stafford loans made through the Federal Family Education Loan, or FFEL, program.)

The payment break and the interest exemption have been in place for more than three years, since the outbreak of the pandemic in 2020.

During that time, no interest accrued on any loans—meaning that unsubsidized loans essentially became subsidized debt for some borrowers.

However, interest will begin accruing on borrowers’ debt again on September 1, and monthly payments will resume in October.

The interest exemption cost the federal government about $5 billion a month.

Some financially strapped borrowers may now be wondering whether it’s a good idea to seek a deferment or forbearance when payments resume, said Mark Kantrowitz, a higher education expert. But “you’re effectively digging yourself into a deeper hole” by pursuing those avenues, Kantrowitz said, since interest will typically accrue during deferment or forbearance.

(There are exceptions, for example if a subsidized loan is deferred or if one of the loan types is deferred due to active medical treatment for cancer.)

Following an income-driven repayment plan, which limits monthly payments, is generally a better option for borrowers unless the financial hardship is short-term, Kantrowitz said.

“Generally, you don’t want to use a deferment or forbearance if you’re able to repay the loan,” he said.