What Are Federal Subsidized Loans?
The federal government subsidizes some types of loans by guaranteeing that it will repay the lender if the borrower defaults or by directly offering a loan to a borrower. The federal government often sets an income threshold for these loan guarantees, subsidizing loans only to low-income borrowers. Some types of federal subsidized loans, such as loans to pay college tuition, cannot be removed through bankruptcy.
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Loan Types
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Two of the most common types of subsidized loans that individuals qualify for are educational loans and housing loans. The federal government also guarantees business loans, including loans to American manufacturers that produce products for the export market and loans to small businesses.
History
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Widespread availability of federal subsidized loans started in the 1970s, according to the Congressional Budget Office. The Federal Financing Bank began to purchase many loans that other government agencies made, allowing these other agencies to increase the number and size of loans that they offered.
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Benefits
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A federal agency can subsidize the loans that a private organization makes, as well as the loans that another government agency makes. Some agencies, such as the Department of Education, directly offer subsidized loans to borrowers. In both cases, the organization has a lower risk because the government is guaranteeing the loan, so it can charge a lower interest rate to the borrower. Because of these reduced interest payments, federal subsidized loans are a good choice for borrowers who qualify.
Interest Coverage
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A federal subsidy can also cover some interest expenses for the loan. The federal Stafford loan program pays the interest expenses for the loan while the student is attending school. If a student qualifies for loan deferral, the Stafford loan program will make the student's interest payments after the student graduates as well. Special situations such as military service and employment at other government agencies can allow a graduate to qualify for loan deferment, as well as financial hardship.
Considerations
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If a federal subsidized loan does not cover the entire cost of tuition, the student may have to apply for an unsubsidized loan that covers the remaining costs. The borrower will be paying a higher interest rate on the unsubsidized loan, so the borrower should use any extra income to pay off the unsubsidized loan first. A borrower should also pay off high interest loans such as credit card balances before making more than the minimum payment on a federal subsidized loan.
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