How Subsidized Loans Work

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When you borrow with a subsidized loan, you can avoid paying interest on the debt—at least temporarily. That feature makes it less expensive to borrow and minimizes the total cost of whatever you’re borrowing for. Whenever you have the option to use subsidized loans, it’s probably an excellent choice. But subsidized debt is only available in limited circumstances, and you may need to show financial need to qualify for these loans.

How Subsidized Loans Work

With subsidized loans, somebody pays your interest charges for you.

Usually, when you borrow money, your lender charges interest on your loan balance, and you are required to pay those charges. For example, lenders may calculate interest costs every day or every month. Those charges can affect you in several ways:

  1. With most loans, when you make monthly payments, a portion of your payment goes toward the interest charged on your balance, and the remainder goes toward reducing your loan balance. 
  2. If you don’t make payments on your loan (because of unemployment, for example), the lender adds those interest charges 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 toward reducing your loan balance.

Any organization can subsidize a loan, and depending on the type of loan, it might be a government organization, a charity, or another group. 

Examples of Subsidized Loans

Student loans are some of the most popular forms of subsidized loans. For example, students with subsidized Stafford Loans or Direct Subsidized Loans enjoy interest-free borrowing in several situations:

  • While enrolled in school at least half-time
  • For the six-month grace period after leaving school
  • During deferment

For those students, the U.S. Department of Education pays the interest costs on their loans.

How You Qualify

Subsidized loans are usually only offered to those who qualify. To qualify, you generally need to demonstrate financial need or meet other criteria.

Student loans: Direct Subsidized Loans are only available undergraduate students with financial need. Graduate students and other students with sufficient financial resources don’t qualify for Direct Subsidized Loans. Instead, they may borrow with unsubsidized loans.

To demonstrate financial need, you need to apply for student aid using the FAFSA form, and the amount you need must be more than the funds you have available. Your subsidized loans will be limited based on the cost of attendance at your school.

Home loans: With certain housing loans like first-time homebuyer programs, you need to live in a particular area and earn less than a specified dollar amount. Other restrictions might 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’s 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 really need—you’ll need to repay all of that money. That may happen when you finish school and begin working, or when you sell a home you bought with subsidized debt.

Options for Unsubsidized Student Loans

If you have loans that are not subsidized, you may have several options for how to handle 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 that may have significant consequences later in life.

Pay as you go: The safest option, if you can afford it, is to pay interest charges as they hit your account. Doing so allows you to minimize your total debt—and it potentially helps with your monthly payment in future years. Paying interest charges each month also enables you to minimize the total cost of your education debt.

Capitalize interest: You may be able to have interest charges added to your loan balance. Instead of making payments to cover the costs each month, you “borrow” more every time lenders apply interest charges. Your loan balance will increase—even though you don’t receive additional funds—because you're adding unpaid interest charges onto your existing loan balance. While that approach is easiest to manage today, you end up with higher costs and higher monthly payments in the future. Read more about capitalizing interest on your loans.