Governmental agencies at the federal, state, and local levels, as well as non-profits, may offer subsidized loans, but federal agencies most commonly extend subsidized loans. When they do, they tend to be reserved for low-income borrowers, meaning that borrowers often have to demonstrate financial need to obtain them. One common example of subsidized loans is a federal student loan through the Department of Education.
How Does a Subsidized Loan Work?
The following example describes the function of these loans:
Types of Subsidized Loans
There are two major subsidized loan offerings:
Federal student loans: The U.S. Department of Education pays for the interest on Direct Subsidized Loans during certain periods—while you’re enrolled on an at least half-time basis, for the first six months after you leave school, or during a deferment (a temporary postponement of payments). However, only undergraduate students who can demonstrate financial need are eligible for Direct Subsidized Loans. Federal home loans: The U.S. Department of Agriculture (USDA) and other federal agencies offer loan programs through which low- or moderate-income borrowers can obtain subsidized home loans. For example, a USDA Single Family Housing Direct Loan comes with a payment-assistance subsidy that reduces a borrower’s monthly payments and the effective interest rate on the loan.
Unlike subsidized loans wherein the lender pays the interest that accrues on the loan during certain periods, unsubsidized loans hold the borrower responsible for paying interest on the loan during all periods.
Subsidized vs. Unsubsidized Loans
Direct Unsubsidized Loans offered by the U.S. Department of Education are a common example. You’ll have to pay any interest that accrues while you’re in school and during grace periods or deferments, resulting in higher total loan costs and monthly payments than you would rack up with a subsidized loan, as the earlier example of the two students shows. The cost differential increases if the recipient of an unsubsidized loan opts not to pay interest during school, which triggers capitalization. A student who takes out a subsidized loan won’t pay interest that accrues during these periods or face capitalization. That said, you don’t have to demonstrate a financial need to be eligible for a Direct Unsubsidized Loan as you do in the case of a Direct Subsidized Loan. Depending on your financial situation, you may find it easier to obtain a subsidized loan.
How to Get a Subsidized Loan
To obtain a subsidized federal educational loan, fill out a Free Application for Federal Student Aid (FAFSA) form to determine what loan types and amounts you’re eligible to receive. For federal home loans, go through the website of the federal agency overseeing the home loan program to determine eligibility requirements and request a loan. Schools will generally send you information on how to accept a federal student loan at your chosen amount. You’ll likely have to fill out a promissory note that outlines the terms of the loan and repayment, and you may need to undergo entrance counseling to ensure that you understand your obligations when you take out the loan. When the loan is ready for disbursement, the school will first take out the necessary amounts for your tuition, fees, and room and board. If there’s money left over, it will be returned to you or your educational needs, such as buying books or covering other expenses.
