choosing between parent plus loans and private loans

Deciding Between a Parent PLUS Loan vs. a Private Loan

Michael Lux Blog, Strategy, Student Loans 0 Comments

When it comes time to find the money for your child’s education, many parents are confronted with a difficult decision… do I get a Parent PLUS loan in my name, or do I co-sign for a private loan in my child’s name?

The best decision will vary from family to family and can depend upon a number of different circumstances.

The Last Resort

Before we get into the specific pros and cons of Parent PLUS loans and private loans, it is important to point out that these two choices should be your last options for funding school.  The preference should be to find grants and scholarships to pay for school.  Once all available grants and scholarships have been acquired, the next choice is a subsidized federal loan, followed by an unsubsidized federal loan.

In almost any circumstance, you child taking out a federal loan will be a better choice than getting a private loan or a Parent PLUS loan.  The federal direct loans that students can sign up for have borrower benefits such as income-driven repayment and student loan forgiveness.  Though most borrowers will ultimately pay off their loan in full, programs like income-driven repayment and student loan forgiveness should be viewed as excellent insurance policies.  For example, the Pay As You Earn (PAYE) repayment plan requires a borrower to pay 10% of their discretionary income towards their student loans.  After 20 years of PAYE payments, any remaining balance is forgiven.   Additionally, PAYE is eligible for Public Service Student Loan Forgiveness.  If your child works for the government or for a 501(c)(3), the loan balance can be forgiven after 10 years of eligible payments.  It is estimated that 25% of the American workforce is eligible for this program.

If your child drops out of school or isn’t able to find a job after graduation, these federal programs afford them an opportunity to address their debt on a low salary or without a job.  Private loans have no such benefits.

Isn’t a Parent PLUS Loan a Federal Student Loan?

While a Parent PLUS loan is a federal loan through the federal government, the repayment options are far more limited than what they are on most other federal loans.  Income-driven repayment is an option on a Parent Plus loan, but the payments are essentially double what they would be if your child took out a federal direct loan.  Repayment plans like PAYE are not an option.  Instead, the only income-driven repayment plan available for a Parent PLUS loan is ICR.  This plan requires 20% of your discretionary income to go towards student loans.

Parent PLUS loans are note eligible for Public Service Student Loan Forgiveness, though the loan can be consolidated into a new loan that is eligible.  The process is a headache, but it can be done.

Your analysis should treat Parent PLUS loans as a hybrid between a federal government loan and a private loan.  It has some of the federal protections, but not nearly as much.

Private Student Loan or Parent PLUS Loan?

The reason parents may opt for a private student loan is that the interest rates could be much lower than what they would be on a Parent PLUS loan.  Parent PLUS loan rates are set by Congress and they have the highest interest rate of all federal student loans.  The private student loan rate will depend upon your credit score, income, and the lender you choose.  If you have a good credit score and income, lenders get competitive and low rates can be found with limited research

Procedurally, the private loan is actually in your child’s name, but because you will have to co-sign the loan, it will appear on your credit report to.  If you wanted to avoid the student loan appearing on your child’s credit report, a Parent PLUS loan would accomplish this goal.

Ultimately, the decision comes down to limited federal perks vs. lower interest rates.  If you are certain of your ability to pay off the loan in a short period of time, the private loan is probably the better option.  If you are desperate to find the money to pay for your child’s education and unsure of how you will repay the debt, the Parent PLUS loan might be a better option.

Both the government and private lenders are guilty if lending more money than borrowers can afford to repay.  Borrow as little is possible and be sure to evaluate all other options before being forced with this choice.

Final Thought

Regardless of the decision you make, student loan debt can last for decades and be a major pain to pay off.  This is a great opportunity to educate your child on personal finance.  Most high schools do a very lousy job teaching this subject and if concepts like compounding interest and rate shopping are not taught at home, it will be an expensive lesson later in life.  It is also important that everybody is on the same page when the paperwork is signed.  Years from now you want to avoid a fight over who agreed to pay what.  Paying for college is a challenge, but it shouldn’t drive a wedge between you and your child.