As the cost of college continues to rise, many families need to borrow money to pay for school. Two popular options are utilizing a Home Equity Line of Credit, or HELOC, and Parent PLUS loans offered by the federal government.
When comparing Parent PLUS loans to a HELOC, many important pros and cons emerge for each option. The best choice for your family will depend upon several different circumstances.
Home Equity Line of Credit: High Risk, High Reward
The big advantage of the HELOC is that the interest rates usually are pretty low. In most cases, HELOC rates will be significantly lower than the interest rates on a Parent PLUS loan.
The downside is that instead of a student loan, you have a second mortgage on your house. A second mortgage is far riskier than a student loan. If you fail to make payments on a student loan, it hurts your credit. If you fail to make payments on a mortgage, you could lose your house.
Tapping into home equity works best for the families that fit the following description:
- Managing mortgage payments will be simple.
- Borrowing for college will be minimal.
- Traditional college borrowing options are not available or are limited.
Even if a HELOC works better than a Parent PLUS loan, it doesn’t mean a HELOC is necessarily the best option. Parents should also consider private student loans and alternative options for college.
Parent PLUS Loans: Expensive Debt, Excellent Protection
If there is a possibility that making payments will be a challenge, Parent PLUS loans are an excellent option.
As federal government loans, the borrower protections are superb. Two aspects of Parent PLUS loans are especially noteworthy. First, parents can make payments based upon what they can afford rather than what they owe. Income-Driven Repayment protects borrowers who lose their job or face an economic hardship. It can also mean zero dollar payments for borrowers living on social security. Second, Parent PLUS loans have excellent forgiveness options. This includes Public Service Loan Forgiveness. If the parent or the child dies before repayment is complete, the loan can be forgiven. These forgiveness/cancellation protections don’t apply to HELOC loans.
The downside to a Parent PLUS loan is that the interest rates are a bit higher than other federal loans, and the loan origination fees are also fairly high. Think of the higher interest rate and loan fees as an insurance policy. Selecting a Parent PLUS loan over a HELOC loan protects your house. The extra spending on interest on a Parent PLUS loan is the cost of the insurance policy. If the Parent PLUS perks are worth the additional cost, then Parent PLUS loans are probably the best option.
Plan C: Cosigning a Private Student Loan
The middle-ground between a Parent PLUS loan and a HELOC loan is cosigning a private student loan.
The private student loan option will have interest rates that are comparable, and possibly better, than a HELOC loan. However, your house is not exposed if you cannot make payments.
The downside is that a private student loan does not have many of the perks offered on a Parent PLUS loan. Public service loan forgiveness and income-driven repayment are not available.
Another important aspect of a private loan is that your child is the primary borrower. Unlike a Parent PLUS loan or a HELOC, both the parent and child are legally responsible for a private student loan.
Parents and children can check current interest rates on private loans by using Credible’s rate checker. Credible currently has seven different student loan lenders on their platform, meaning one application provides a pretty good idea of rates across the market.
Credit Requirements for Parent PLUS Loans vs. HELOC
Even if your home has a lot of equity, qualifying for a Parent PLUS loan will probably be easier.
Parent PLUS loans do have a credit check. However, the Parent PLUS credit check only looks for an adverse credit history. As long as none of the following appears on your credit report, you should pass the credit check:
- Accounts with a total outstanding balance greater than $2,085 that are 90 or more days delinquent as of the date of the credit report, or that have been placed in collection or charged off during the two years preceding the date of the credit report.
- Default determination during the five years preceding the date of the credit report.
- Bankruptcy discharge during the five years preceding the date of the credit report.
- Repossession during the five years preceding the date of the credit report.
- Foreclosure during the five years preceding the date of the credit report.
- Charge-off/write-off of a federal student aid debt during the five years preceding the date of the credit report.
- Wage garnishment during the five years preceding the date of the credit report.
- Tax lien during the five years preceding the date of the credit report.
Getting approved for a HELOC will have credit score requirements, debt-to-income ratio requirements and may also require a home inspection.
Looking at the Big Picture
Don’t make the mistake of thinking about college in one-year increments. The decisions you make this year can have a massive influence on future borrowing. For example, if you take out a ton of Parent PLUS loans, it might be harder to later qualify for a HELOC. However, if you face an indeterminate amount of debt and are concerned about your ability to pay it off, Parent PLUS loans are probably a better option.
Sometimes it is also essential to ask the tough questions. Instead of debating a HELOC vs. a Parent PLUS loan, maybe the question is: Can we afford this college? What other alternatives exist?
This short guide to planning and paying for college should help answer these challenging questions.