Should I First Repay Subsidized or Unsubsidized Student Loans?

Not all student loans from the federal government are the same, and which one you pay off first can mean a difference of thousands of dollars. The government offers subsidized loans, where the government pays interest while you defer the loan, or unsubsidized, where you pay any interest that accrues. All loans from private lenders are unsubsidized, and the same principles apply to both unsubsidized private loans and unsubsidized federal loans. In general, you probably want to repay unsubsidized loans first.

Identification

Whenever you have multiple loans, you should pay off the loan with the highest interest rate first, because the balance on the loan with the higher rate accrues the fastest. In general, the government sets a higher rate for unsubsidized loans than subsidized loans, because subsidized loans usually go to low-income families. In the 2011-2012 school year, for instance, the unsubsidized Stafford loan has an interest rate of 6.8 percent, but only 3.4 percent for the subsidized loan version, according to FinAid. Private student loans tend to have the highest interest rates of any student loan.

Deferment

Another reason to pay off unsubsidized loans first is that you might be able to avoid paying interest on the subsidized loans by deferring them. The government allows holders of subsidized loans to defer payment automatically due to certain hardships, such as unemployment, with the government paying the interest. Once you pay off your unsubsidized loans, you can start on your subsidized ones.

Considerations

You might pay off subsidized loans first in some situations. If you locked in low rates on your unsubsidized loans, then the rates on your subsidized loans may exceed those on your unsubsidized ones. If you have several subsidized loans, you might pay them off first to eliminate the total amount of money you pay on loans each month, because each loan has a minimum monthly payment, or just to reduce the number of bills you receive each month.

Tip

Ideally, you should pay off loans in a manner that saves you the most money on finance charges. You may want to plan your career or education around repayment. For instance, you might go back to grad school to defer your subsidized and unsubsidized loans. Also, the government usually charges a lower rate on repayment of federal loans while you attend school.