Subsidized Student Loans
Not all loans are created equal. Some are government funded, others are not. Some are subsidized, others are not. There are other basic differences between student loans, but among those that distinctly stand out are the federal-funded and the subsidized.
If you’re new to the world of student loans, it’s a good idea to know these differences before you actually choose the means to finance your college education. A good choice made today or just before signing that promissory note could make a major difference, in terms of dollar value, when you start repaying your loan after graduation.
Loans funded by federal money are not automatically subsidized. But if its subsidized, it means interest charges while you’re attending school are not charged against you. Instead, they will take effect after the completion of your college course, or when you start repaying. This translates to major savings for you. Imagine four years of no-interest charges! That has already translated to about a couple of thousands in savings for a loan of $25,000.
If you are forced to take out an unsubsidized loan, your lender will bill you for interest charges almost as soon as your loan is released. If you don’t pay off these interest charges, your lender will add this cost to your principal loan. After four years, a loan principal of $25,000, for example, could balloon into $30,000 or more, depending on how your bank computes the loan, especially if the computation is based on variable rate.
A Subsidy Does Not Eliminate Interest Charges
A subsidy does not eliminate the existence of interest charges. It just means another entity, usually the government, assumes payment of interest charges. It’s a form of help provided by the government to certain industries to prevent their decline. In the case of subsidy for student loans, the government is assisting not just the students, but schools and banks.
All loans emanating from federally-sourced funds are not automatically subsidized. Two of the most popular loan types are the direct subsidized and the direct unsubsidized. They are from the Direct Stafford loans of the William D. Ford Direct Loan Program.
Direct subsidized loans are intended for students with the financial need based on the results of the Free Application for Federal Student Aid, which also determines the amount you can borrow. The subsidy allows you to be free of interest charges while you’re still in school and during the grace period that was allowed to you. If you applied for deferment and received an approval, you’re not charged interest as well during the deferment period.
With a direct unsubsidized loan, you don’t have to show proof of neediness. Like subsidized loans, your school determines how much you will need in financial aid. If you have both subsidized and unsubsidized loan, you have to pay interest charges for the unsubsidized component as soon as loan funds are released.
You’re allowed to pay the interest while you’re still in school and during the grace and deferment periods included in your loan package. In this way, you generate substantial savings during the actual repayment period.
If you don’t pay interest immediately as billed, you will pay a much higher principal during the repayment period because unpaid interest charges are accrued into your principal loan and you will be charged interest based on a higher principal loan This is called capitalization, a process where unpaid interest charges are capitalized and becomes part of your unpaid principal loan
Federal Unsubsidized
While federal subsidized is the preferred type of loan by most students, federal unsubsidized loans are popular as well to some students.
This is because this type of loan sets a higher maximum cap for a loanable amount, usually sufficient to cover all your school expenses. As an undergraduate, you can borrow between $4,000 and $5,000 or more per academic year, so you’re not likely to need additional funding from private student loans, which could command higher rates and more rigid payment terms.
As long as you’re able to pay in advance, about $25 a month in your initial year for a loan of $5,000, then you have nothing to fear about your loan getting too expensive to pay. Some students simply scrimp on their food allowance and/or take on cheaper housing to enable them to use part of their loan to cover the cost of interest. Others accept a part-time job as long as their work does not conflict with their school schedule.
Another possibility is to apply for an unsubsidized federal loan if your subsidized federal loan is not sufficient to cover all your school expenses. Under this scenario, you can still pay the unsubsidized component of your loan in advance, but at much lower monthly cash out. If you qualify for direct Stafford loans, you can borrow up to $5,500, but no more than $3,500 should be subsidized, according to a student manual entitled “Funding Education Beyond High School” released in 2011 by the Washington-based Federal Student Aid Information Center.
The same source reports that dependent undergraduate students unable to obtain PLUS loans can receive up to a maximum $31,000 in aggregate, with a maximum subsidized loan component of $23,000 Independent undergraduate student with PLUS loan can obtain a maximum of $57,000, with a similar maximum subsidized loan component of $23,000
Graduate and professional students are given more leeway in terms of loan benefits. They’re entitled to an annual maximum amount of $20,500, but only $8,500 of this can be subsidized. They’re entitled up $138,500 for the duration of their course, but no more $65,500 can be subsidized. Their loan limit includes the amount they received in their undergraduate course.
With a federal unsubsidized loan – usually coming from Perkins and Stafford – you can use the longer grace period for repayment and deferment to buy more time before you start paying off your loan. Your payments of interest charges in advance can work wonders for you, if you decide to apply for the government’s new and other upcoming student loan relief programs. They speak well of your character and your desire to meet your financial obligations.
Premier Natural Resource
In the light of the crisis facing the country’s premier natural resource, the government is moving swiftly to address the core of its problem – the rising number of unpaid student loans and lack of jobs for fresh graduates.
If you’re an undergraduate about to pay your subsidized loan between July 1, 2011 and June 2012, your interest rate has been reduced to 3.4%, or 50% lower than unsubsidized fixed rates, which still hover at 6.8%.
Student loan subsidies are available not only through the Direct Loan program of the government, but also through another program called Federal Family Education Loan (FFEL). Both Direct Loan and FFEL have identical loan terms, but it’s the colleges that choose which program to use to help them provide federal funded loans to their students.
The federal government, through the Department Education, gives banks and other lenders, like Sallie Mae, a guarantee against default losses and a guaranteed rate of return. These guarantees minimize the risk of private lenders because it’s the federal government that absorbs much of the risk provided by student loans. On the other hand, the system effectively reduces the work of the federal government in terms of loan distribution and servicing.
Guarantee Against Default
Private student loan providers receive an almost risk-free 97% guarantee against default losses from student loans. If a borrower fails to repay a student loan, the federal government pays the lender 97% of the outstanding balance, including principal and accrued interests.
According to federal sources, the government paid private lenders a total of $8.5 billion in 2008 for defaulted loans from a total loan volume of $413 billion for that year. The amount returned by the government to private lenders represents only 2.06% of the total volume of loan transactions.
Guaranteed Interest Rate
The guarantee given by the government to private student loan providers to ensure that they get their share of guaranteed interest payment is called SAP or Special Allowance Payment. The guarantee is based on a three-month commercial paper with an addition of 2.34 percentage points when loan is already due for repayment and 1.74 percent points when the student borrower is still attending college.
If the interest payments made by the student are not enough to cover the lender’s guaranteed interest rate during a specified period, usually a financial quarter, the government pays the private lender a SAP to cover the difference. This arrangement effectively assures lenders that they get their just share of the interest paid by the borrower. In the event, however, that the lender gets more than his just share of the interest, he is obliged to return the excess to the federal government.
The use of subsidies to protect various industries is a complex mechanism used by the government to address the problems of critical sectors in the economy. With student loans almost outpacing credit cards in terms of volume of transactions, government subsidies can play a critical role to help debt-ridden students recover just in time to play a much bigger and more decisive role in shaping their own future and the future their country.
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