There is a ton of fine print associated with federal student loans. Certain loans qualify for certain repayment plans. Some people are eligible for some programs while others are not. Somehow, consolidating loans can turn loans that are not eligible for certain programs into loans that are eligible. To say that things are unnecessarily complicated would be a huge understatement.
It is in this tangled up web of rules and regulations that some borrowers make an incredibly expensive mistake. They consolidate their Parent PLUS loans with other federal loans.
Parent PLUS Loan Consolidation
Why is it a mistake to combine Parent PLUS loans with other federal loans? There are certain limitations that apply to Parent PLUS loans. For example, Parent PLUS loans are not eligible for the best repayment plans. These plans include income driven plans such as IBR (Income Based Repayment), PAYE (Pay As You Earn) and REPAYE (Revised Pay As You Earn). The only income driven plan that Parent PLUS loans are eligible for is the Income-Contingent Repayment Plan (ICR).
To the average borrower, these plans all sound pretty much identical. In reality, there are huge differences between these plans. All of these plans require borrowers to pay a certain portion of their discretionary income towards their student loans each month. The idea is that you pay what you can afford, regardless of how much you owe. However, these plans require different percentages of your discretionary income. PAYE and REPAYE are great because they only require 10%. IBR is a little bit more expensive, requiring borrowers to pay 15%. ICR is the most expensive, requiring 20%. Outside of the percentages, there are other differences between these repayment plans, but the important part is this: for many borrowers signing up for ICR will result in double the monthly payment.
Why Does ICR Even Exist?
Once upon a time, ICR was the very best plan available. For borrowers who didn’t have jobs, or who could afford their monthly payments, ICR was awesome. Payments were based upon income, not debt levels.
As time passed, Congress and the Department of Education decided that 20% was too high. A new plan came along requiring only 15% of a borrowers monthly discretionary income, and IBR was born. As time passed, new plans came along requiring only 10%.
Even though ICR was once the best, it has become an outdated dinosaur. Unfortunately for borrowers with Parent PLUS loans, it is the best plan that their loans are eligible for. If you have a Parent PLUS loan, you cannot sign up for IBR, PAYE, or REPAYE with that loan.
Getting into trouble…
For borrowers with their own federal loans and Parent PLUS loans, they have mixed eligibility problems. Some loans can sign up for the better plans while others cannot. In this situation, the best option is to pay off the Parent PLUS loan first. Once that loan is eliminated, the other loans can be enrolled in the for forgiving repayment plans.
The worst thing that can be done is consolidating them into a federal direct consolidation loan. The government will then apply the restrictions that applied to the Parent PLUS loan to the new larger loan. As an example, suppose you have $25,000 in federal loans from when you went to school and $5,000 in Parent PLUS loans to pay for your child’s education. You can combine the loans into a $30,000 direct consolidation loan. The problem is the government will treat the new loan as though it was a Parent PLUS loans. The $25,000 that would have been eligible for IBR or REPAYE is now only eligible for ICR. It can be an expensive mistake.
Avoiding the mistake…
Combining Parent PLUS loans with other federal loans is almost always a mistake. The way the government handles things seems wrong on three levels.
First, the fact that there are so many different repayment plans with so many different rules makes things unnecessarily confusing.
Second, because it is such a mistake to combine the loans, it should be a financial move that isn’t permitted, yet the government continues to let people unknowingly make this mistake.
Finally, many customer service representatives do not understand the magnitude of the mistake. If they don’t understand why it is a bad idea, they cannot warn borrowers before it is too late.
The Worst Part
We haven’t even gotten to the worst part of this mess. Should you have accidentally made this huge mistake, there is no way of fixing it.
Once the loan is consolidated, there is no undo button, there is no fix. A consolidated loan cannot be “unconsolidated”.
Combining Parent PLUS loans with other student loans in a direct consolidation loan can be a huge mistake. Sadly, it is an easy one to make, and no good way of fixing it.
If you or anyone you know has Parent PLUS loans in addition to other federal student loans, be sure to warn them.
(Editor’s Note: There are also Graduate PLUS loans… these loans sound very similar to Parent PLUS loans, but combining them with other federal loans is not the same huge mistake. The Graduate PLUS loans are eligible for the better repayment plans. Dealing with these loans is an entirely different circumstance.)