Parent PLUS loans are a common method that parents use to help their children afford college. Unfortunately, many families make mistakes with their Parent PLUS loan decisions. Today we will discuss the strategy that goes into deciding whether or not a Parent PLUS loan is a good idea. We will also look at ways to avoid Parent PLUS loans contributing to a student loan nightmare.
What is a Parent PLUS Loan?
A Parent PLUS loan is a federal student loan. What makes a Parent PLUS loan unique from most other student loans is that it is in the name of the parents and not the student. This means the loan will not appear on the student’s credit report, nor is the student legally obligated to pay down the debt. These responsibilities fall upon the parent signed to the loan.
Unlike most federal student loans, Parent PLUS loans are not eligible for many of the most popular repayment plans, such as Income Based Repayment and Pay As You Earn. Additionally, Parent PLUS loans come with higher interest rates than the loans made directly to students. Finally, Parent PLUS loans also have high origination fees. At present, the origination fees are just over 4%. This origination fee is charged when the loan is disbursed and added to the loan balance from day one.
The Department of Education has a nice summary on the basics of Parent PLUS loans, including qualification requirements, interest rates, and repayment options.
Due to the limitations of Parent PLUS loans, we almost always recommend that students first take out federal direct loans before considering a Parent PLUS loan.
When is a Parent PLUS Loan a Good Idea?
Once a student has reached the borrowing limit for federal undergraduate loans, Parent PLUS loans become a reasonable option.
Families caught in this situation basically have three choices:
- Borrow a private loan
- Borrow a Parent PLUS loan
- Look into a less expensive school
Each option comes with major advantages and distinct disadvantages.
Private Loans vs. Parent PLUS Loans
We have already covered this precise issue in more detail.
The short version is that private loans will normally have lower interest rates and no origination fees (provided you shop around a bit). The downside to private loans is that they are much riskier, as there are no student loan forgiveness programs, nor are their repayment plans based upon your income. Qualifying for a private loan can often be more difficult than getting a Parent PLUS loan.
Private loans are usually a better choice for families that a certain to be able to repay the loan in a short period of time. If there is any doubt about how the loan will be repaid, a Parent PLUS loan is often the better choice.
Think About Less Expensive Schools
Too many families get caught up in the idea of a “dream school.” Those that borrow too much money often find their dream becomes a nightmare after graduation. A simple rule of thumb for borrowing is that the total student debt at graduation should be less than the expected starting salary.
If your child is maximizing their federal borrowing and not able to afford the school, it might be time to have a hard conversation.
Communicate PLUS Loan Expectations
Parent PLUS loans are borrowed by the parents, appear on the parent’s credit report, and are used to fund a child’s education.
Many children expect their parents to pay off the Parent PLUS loan while the parents expect their children to pay off the loan. This debt can often cost more than a new car, so it is critical that everyone is on the same page about what is expected.
Making things even more difficult is that repayment of Parent PLUS loans can be complicated. Qualifying for certain repayment plans and forgiveness programs takes an extra step not usually required for other federal loans.
College is already expensive. Don’t let it cost you a relationship with a loved one. Discuss who will be paying the bills, how they will afford them and what happens is there are challenges finding a job or graduating.
In many ways, Parent PLUS loans are playing with fire. They can be a very useful tool in accomplishing great things, but they can also be very dangerous due to very high borrowing limits. Before any debt is borrowed, make sure everyone involved understands the options available.