When it comes time to find the money for your child’s education, many parents face 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 several different circumstances.
Parent PLUS and Private Loans: The Debt of Last Resort
Before we get into the specific pros and cons of Parent PLUS loans and private loans, it is essential 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. After maximizing all possible grants and scholarships, the next choice is a subsidized federal loan, followed by an unsubsidized federal loan.
A federal loan in the student’s name is preferable to private loans and Parent PLUS loans in almost any circumstance. 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, borrowers should view federal protections like income-driven repayment and student loan forgiveness 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. Forgiveness is available after 20 years of PAYE payments. Additionally, PAYE is eligible for Public Service Student Loan Forgiveness. If your child works for the government or a 501(c)(3), the balance is eligible for forgiveness after ten years of certified payments. Estimates show that 25% of the American workforce is eligible for this program.
If your child drops out of school or cannot find a job after graduation, these federal programs allow them to address their debt on a low salary or without a job. Private loans have no such benefits.
Families considering large amounts of Parent PLUS debt or private student loan debt may wish to consider other school options. The best choice may be pursuing a four-year degree while accumulating a more manageable amount of debt.
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 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 Income-Contingent Repayment (ICR). This plan requires 20% of your discretionary income to go towards student loans.
Parent PLUS loans are not eligible for Public Service Student Loan Forgiveness. However, federal direct consolidation can fix the issue. The process is a headache, but parents can do it.
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 vs. Parent PLUS Loans: Interest Rates
Parents may opt for a private student loan because the interest rates could be much lower than what they would be on a Parent PLUS loan.
Congress sets Parent PLUS Loan rates. They have the highest interest rate of all federal student loans. The private student loan rate will depend upon credit score, income, and the lender chosen. If you have a good credit score and income, lenders get competitive. Borrowers can find low rates with minimal research.
Procedurally, the private loan is actually in your child’s name, but it will appear on both credit reports because you will have to co-sign the loan. 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 sure of your ability to pay off the loan in a short period, 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 as possible and be sure to evaluate all other options before being forced with this choice.
A Valuable Finance Lesson
Families weighing Parent PLUS loans vs. Private loans should use this as an opportunity to educate children on personal finance. Most high schools do a lousy job teaching this subject. 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 vital 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.