If you have to borrow money to help your child pay for college, there are many routes to choose from.
Most experts, myself included, believe that federal direct student loans are the best option for the vast majority of borrowers. The downside with federal loans is that the borrowing limits are quite low for undergraduate students.
To cover the remaining gap, many families opt for one of the following three options:
- Parent PLUS loans made directly to a parent
- Private loans are issued to the child but usually cosigned by a parent
- HELOC loans to tap into your home’s equity
Each option has distinct advantages and risks, and there isn’t any way to rank these choices. A private loan might be the best choice for some families, while others are better off with a HELOC loan or a Parent PLUS loan. The purpose of this article is to help families determine the best loan for their individual circumstances.
A Warning from the Sherpa: In some cases, the best loan is no loan at all. College is increasingly expensive. Before determining the best loans, make sure the college and program selected is the right investment.
Parent PLUS Loans: Federal Loans with a Catch
Parent PLUS loans are federal student loans, but they have a few significant limitations.
For starters, in a Parent PLUS loan, the parent is legally responsible for repaying the loan. The student never receives a bill, and the loan doesn’t appear on their credit report.
As federal loans, Parent PLUS loans are eligible for income-driven repayment and student loan forgiveness. However, there is another catch. The ICR plan is the only income-driven repayment plan available for Parent PLUS loans. ICR payments are the highest out of all the federal IDR plans. Additionally, enrolling Parent PLUS loans in ICR is complicated as borrowers must first consolidate. Likewise, earning Public Service Loan Forgiveness is also more difficult for Parent PLUS borrowers.
Despite these limitations, Parent PLUS loans offer great borrower protections.
Who Benefits from Parent PLUS Loans?
If you are worried that you might not be able to afford the debt, Parent PLUS loans are probably the safest of the three options in today’s comparison.
If you are nearing retirement age, Parent PLUS loans are often an excellent choice. Borrowers living on social security often qualify for $0 monthly payments for their Parent PLUS loans.
When are Parent PLUS Loans a Mistake?
If you only need the money for a short period of time, Parent PLUS loans might be a bad option. Parent PLUS loans have the highest loan origination fees out of all federal loans. They also have the highest interest rates of all federal student loans.
If you expect to borrow money to help a child pay for school and have no doubt in your ability to repay the debt eventually, looking elsewhere might be the best choice. Parent PLUS loans have the most extensive safety net, but the price of that safety net is higher interest rates and origination fees.
Paying for College with Private Student Loans
Students technically could borrow private loans without the help of their parents. However, to qualify, they need a decent credit history and income. Thus, most private loan borrowing requires the help of a cosigner.
As a cosigner, the parent has the legal responsibility to repay the debt if the child cannot make payments. Sadly, this legal burden happens far more often than most parents expect. If a student doesn’t graduate or can’t find a job, they may not be able to afford their loans. Even if the student finds a job, they still might struggle to repay their loans. Cosigners must be prepared to take over repayment.
Additionally, if the student dies before repaying the loan, the cosigner may have to repay the loan under the terms of the loan agreement. For this reason, a life insurance policy may be a good idea for cosigners.
The big benefit of a private loan is that interest rates could be considerably lower than on a Parent PLUS loan. The key is to shop around and check rates with various different lenders.
When is a Private Loan the Best Choice?
Private loans are riskier than a Parent PLUS loan, but the interest rate is often much lower.
If you need cash to pay for the next semester or two and expect the repay the debt relatively quickly, a private loan is probably the best option.
Another advantage to private loans is that they may help your child establish a credit history. It’s not the best way to build a credit profile, but it does come in handy for some borrowers.
When to Avoid Private Loans
Overwhelming private loan debt is a nightmare.
Private lenders are far less flexible when it comes to repayment plans and struggling borrowers. Too much private debt can result in unaffordable bills and a destroyed credit profile.
Additionally, massive private debt can also be an issue for students who want to buy a house after graduation. While the debt can help a credit score, it can devastate a borrower’s debt-to-income ratio. Numerous private student loans can make it difficult for both the borrower and the cosigner to qualify for a mortgage.
Using Home Equity Lines of Credit to Pay for College
With home values growing dramatically over the last few years, many parents what to use that equity to pay for college.
The big advantage of the HELOC approach is that banks may offer very low interest rates.
The problem with this strategy is that you are risking your house if you can’t pay the bills.
Using a HELOC to pay for school is a high-risk/high-reward decision. The actual cost of borrowing may be the lowest, but the danger of not making payments is by far the highest.
Sherpa Tip: Don’t assume that a HELOC will have lower interest rates than a private loan. It is certainly possible that the best rate comes from a HELOC loan, but private loan lenders may offer even better rates.
If interest rates are the biggest priority, check rates with both HELOC lenders and private loan lenders.
Deciding Between a HELOC, Private Loan, and a Parent PLUS Loan
For many families, the how to pay for college question is a question of risk aversion. Parent PLUS loans usually get the edge if there is a concern about keeping up with payments. As the risk of repayment concerns drops, chasing interest rates becomes the ideal approach.
However, there are other factors to consider. Parent PLUS loans only show up on the parents’ credit reports. Private loans usually appear on the credit report of the borrower and the cosigner.
Finally, there is the question of availability.
HELOC loans are limited by your home’s equity. Private loans become harder to qualify for as your debt accumulates. Parent PLUS loans have fewer limitations. For this reason, it is vital to think years in advance. The ideal strategy looks at how to pay for an entire degree rather than just one semester.
My daughter only has 2 1/2 semesters left to graduate. She qualifies for several scholarships and grants, so we haven’t had to take out private loans or a Parent Plus loan until now. I am trying to decide between those, as the interest rates would be pretty similar, but I work for my state government, and am not at all close to retirement (at least 22-23 years before I reach full retirement age). It looks like we would have to borrow about $10-12k to finish her degree. Would it be better to go with a Parent PLUS loan to possibly pursue PSLF, or to go with a private student loan? Thank you!
The best choice would be a federal loan for your daughter. Once you have maxed out that option, I’d lean toward a Parent PLUS loan based on the information you have provided. With private loan interest rates the same as a Parent PLUS loan, the possibility of PSLF is a nice tiebreaker.