When you borrow with a subsidized loan, you can avoid paying interest on the debt, at least temporarily. This feature makes borrowing less expensive and minimizes the total cost of everything you borrow. Whenever you have the option of using subsidized loans, it’s probably a great choice. But subsidized debt is only available in limited circumstances, and you may need to demonstrate your financial need to qualify for these loans.
How Subsidized Loans Work
With subsidized loans, someone pays your interest for you.
Usually, when you borrow money, your lender charges interest on your loan balance and you have to pay this fee. For example, lenders can calculate interest charges daily or monthly. These fees can affect you in several ways:
With most loans, when you make monthly payments, part of your payment goes towards interest charged on your balance and the rest goes towards reducing your loan balance.
If you don’t make a payment on your loan (due to unemployment, for example), the lender adds that interest to your loan balance, so you end up owing more each month.
With subsidized loans, your loan balance does not increase when you skip payments, and any payments you make go towards reducing your loan balance.
Any organization can subsidize a loan, and depending on the type of loan, it can be a government organization, a charity, or another group.
Examples of subsidized loans
Student loans are among the most popular forms of subsidized loans. For example, students subsidized Stafford Loans or Subsidized Direct Loans are eligible for interest-free borrowing in several situations:
- While enrolled in school at least half-time
- For the six-month grace period after leaving school
- During adjournment
For these students, the US Department of Education pays the interest charges on their loans.
How you qualify
Subsidized loans are generally only available to eligible individuals. To qualify, you usually must demonstrate financial need or meet other criteria.
Student Loans: Subsidized Direct Loans are only available to undergraduate students with financial needs. Graduate students and other students with sufficient financial resources are not eligible for direct subsidized loans. Instead, they can borrow with unsubsidized loans.
To demonstrate financial need, you must apply for student financial aid using the FAFSA form, and the amount you need must be greater than the funds you have available. Your subsidized loans will be limited based on the cost of attending your school.
Home Loans: With some home loans like first-time homebuyer programs, you must live in a particular area and earn less than a specified amount. Other restrictions may include the need for a purchased home to meet health and safety standards, and the need to limit the profits you can earn on the sale of your home.
It is best to borrow with subsidized loans whenever possible. If you need more money, you can also borrow with unsubsidized debt. But only borrow what you need – you’ll have to pay back all that money. This can happen when you finish school and start working, or when you sell a house you bought with subsidized debt.
Options for Unsubsidized Student Loans
If you have loans that are not subsidized, you may have several options for managing interest charges. The choice you make affects the total amount you pay over your lifetime. It’s tempting to pay as little as possible, but this can have significant consequences later in life.
- Pay as you go: The safest option, if you can afford it, is to pay interest charges when they hit your account. This allows you to minimize your total debt, and it can potentially help you with your monthly payment in years to come. Paying interest charges each month also allows you to minimize the total cost of your student loan debt.
- Capitalize interest: You may be able to add interest charges to your loan balance. Instead of making payments to cover costs each month, you “borrow” more each time lenders charge interest. Your loan balance will increase, even if you don’t receive additional funds, because you add unpaid interest to your existing loan balance. While this approach is easier to manage today, you end up with higher costs and higher monthly payments in the future. Learn more about capitalizing interest on your loans.
