How Subsidized Loans Work

an illustration of a money tree
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When a loan is subsidized, the borrower does not have to pay interest on the debt (at least temporarily). Subsidized loans make it less expensive to borrow, but they are generally only available to borrowers who can show financial need.

How Subsidized Loans Work

When you borrow money, interest is charged on your loan periodically – every day or every month, for example. Unless your interest costs are subsidized, you’ll have to pay those costs (either in the form of higher monthly payments in the future, or a monthly payment to cover the interest charges).

With subsidized loans, somebody else pays those charges so you don’t have to.

Who Provides the Money

Anybody can subsidize a loan. Depending on the type of loan, it might be a government organization, a charity, or some other group. Student loans are among the most common types of loan subsidies. With those loans, the US government pays interest costs for certain students. For example, students with subsidized Stafford Loans enjoy interest-free borrowing while they are enrolled in school.

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. For example, with certain housing loans (like first time home buyer programs), you need to live in a certain area and earn less than a specified dollar amount. Other restrictions might include the need for the home to meet health and safety standards, and the need to limit profits you can earn on the sale of your home.

Subsidized Student Loans

Student loans are probably the most widely used type of subsidized loan. If your loan is subsidized, no interest is charged to you as long as you have demonstrated financial need and:

  • You are enrolled at least half-time, or
  • You are in a six-month grace period after graduation, or

To demonstrate financial need, you’ll need to apply for loans using the FAFSA form, and the amount you need must be more than you have available (but your subsidized loans will be limited by the cost of attendance at your school).

It’s best to get subsidized loans if possible. If you need more, you can always borrow with unsubsidized debt as well (but only borrow what you really need – you’ll have to pay it all back someday).

Unfortunately, graduate students and professional students can no longer get subsidized loans – you’ll pay interest on everything you borrow.

Options for Unsubsidized Loans

If your loans are not subsidized, you may be able to choose how to handle the interest.

  • Pay as you go: the best option, if you can afford it, is to pay interest charges as they are assessed. This allows you to minimize your total debt, as well as the amount you’ll have to pay every month for years to come. It will also minimize the total amount of interest you pay on your education debt.
  • Capitalize interest: another option is to have interest charges added to your loan balance. Instead of making payments to cover the costs as they come up, you just “borrow” more each time interest is charged. Your loan balance will increase – even though you won’t get any more money – and you’ll end up with higher costs and higher monthly payments in the future. Read more about capitalizing interest on your loans.