Will you need to borrow to pay for college?
As I mentioned in my last post, if you need to borrow the best loan will usually be the federal Direct Loan. These loans are the responsibility of students, but parents can repay this loan for their children.
If you missed the post on student loans, here it is:
When families need to borrow more for college, here are three main options:
- Federal PLUS Loan.
- Home equity line of credit.
- Private college loan. (I will cover private loans in my next post.)
The PLUS Loan is designed to allow parents to borrow to pay the costs that aren’t covered by a child’s financial aid package. Consequently, the maximum amount that a parent can borrow will depend on how much aid a student received in grants and federal student loans, as well as the school’s cost of attendance.
Here’s an example of how the PLUS works:
A freshman receives a $10,000 merit award from his/her college, as well as a federal Direct Loan of $5,500. The school’s cost of attendance, which would include tuition/fees, room/board, books and transportation, is $50,000.
$50,000 (cost of attendance) – $15,500 (grants/student loan) = $34,500 (amount can borrow via PLUS)
The PLUS Loan originally was originally launched in 1980 to primarily help middle and upper-middle-class families send their children to expensive private colleges. The initial maximum loan was just $3,000 per year, which adjusted for inflation would equal $8,500 today.
Qualifying for a PLUS Loan
Parents can borrow far more than the earlier limits and that is one reason why parents need to be careful when turning to the PLUS Loan. The other reason why the PLUS can be dangerous for some borrowers is because no one is checking to see if parents have the financial ability to repay what can be staggeringly large amounts of debt.
Some parents have gotten into financial trouble because they borrowed far more than they could handle simply because the federal government was willing to lend them the money.
A parent can qualify for a PLUS without a good credit score or the kind of salary that would support future payments. A borrower, however, can’t have certain adverse black marks on his/her credit history. For instance, parents can’t be more than 90 days late on paying a debt and their credit history can’t be marred by a bankruptcy, foreclosure or wage garnishment in the last five years.
If you don’t qualify for a PLUS Loan, your child can borrow more through the federal student loans. (See the chart in the previous lesson entitled, Best College Loans for Students).
If parents can’t qualify for the PLUS on their own, they can still borrow through the PLUS Loan if they can find a cosigner who does not have an adverse credit history.
PLUS loan obligations can rarely be dismissed in bankruptcy court. Lenders can pursue delinquent PLUS borrowers by garnishing wages, income tax refunds and even Social Security checks. In some cases, a parent with a professional license may not be able to get it renewed if his or her credit rating has been destroyed due to bad debt.
The PLUS does offer one welcome protection. If the parent who took out the PLUS dies, the PLUS Loan will be forgiven. Because of this provision, it could be advantageous for a parent in poor health to turn to the PLUS Loan.
The government will also discharge the PLUS debt if the parent borrower becomes “totally and permanently disabled.”
Everyone gets the same terms.
Everyone borrowing through a PLUS Loan receives the same rate for the year. The interest rate is tied to the ten-year U.S. Treasury so the rate will be different each year. For the 2016-2017 school year, the interest rate is 6.31% with a 4.27% fee tied to the amount of the loan.
Parents have the option to begin making PLUS Loan payments right away or to wait until their child graduates or otherwise leaves school. To cut down on the total cost of the loan, parents should, if at all possible, begin making payments immediately.
The federal parent loan isn’t nearly as popular as the federal Direct Loan for students and it’s no surprise considering the high interest rate and fees. The terms are outrageously high and the federal government makes billions of dollars off parents who borrow this way.
There is no safety net.
Students who borrow through the federal Direct Loans can enroll in federal repayment programs if their debt exceeds their ability to pay based on their income and household size. The best federal repayment program is called Pay As You Earn. Parents who rely on PLUS Loans don’t have a federal safety net. Students, however, who take out PLUS Loans for graduate and professional-degrees, can take advantage of PAYE and other federal repayment programs.
Check PLUS debt at individual schools.
Expensive for-profit and non-profit private schools tend to have more parents borrowing to cover college costs. The Chronicle of Higher Education created a search engine that shares what the average PLUS Loan amount is for individual schools. You can also sort in a variety of ways including by the average amount borrowed. That’s the factor I used to generate the list below of the schools where the average debt per family is the highest.
Calculate future payments.
Since the federal government isn’t significantly limiting parent borrowing, it’s up to parents to avoid over borrowing. One way to calculate how much is safe is to use the federal loan repayment estimator. I used the calculator to estimate the potential costs using different repayment methods.
In my hypothetical example, I calculated what $50,000 worth of PLUS Loans with a 7.21% interest rate would cost to a family. You’ll see the results below.
The cheapest repayment method would be the standard 10-year plan, which would result in payments that would be slightly less than $600 a month. The borrower would ultimately pay $70,908. The most expensive option would be a repayment stretched over 25 years with the initial payments being smaller. Using this method, the tab would balloon to $118,571.
Home Equity Loans
For many parents who have equity in their homes, the home equity line of credit will be the best option.
For parents with excellent credit, the interest rate on a line of credit will be lower than any other available loan for college.
For many parents, their home equity line is going to offer a better starting interest rate (HELOCs offer variable interest rates) and if you itemize on your taxes, the interest is deductible. In addition, bankruptcy remains an option if parents encounter extreme financial difficulty.
As with private college loans, the better the credit history, the better the interest rate offer.
If you borrow through a home equity line, you will reduce the equity in your home, which, in turn, could lessen the financial aid hit when applying to 229 mostly private schools that use the CSS/Financial Aid PROFILE. The vast majority of colleges and universities in this country, however, do not consider home equity at all because they only use the Free Application for Federal Student Aid, which doesn’t even ask if parents own a primary home.
There is a significant difference between borrowing through a home equity line of credit and a second mortgage. With a line of credit you can take out only what you need, such as when it’s time to pay a college tuition bill.
With a second mortgage, you get the entire amount of loan upfront and will have to pay interest on this money from the start. Any unspent money sitting in a bank account, will be considered parental assets.
Even worse is if a parent takes out the money and the child will be going to a school that only uses the FAFSA. By getting a second mortgage, the parents took money from an asset that the FAFSA ignores (primary home) and converted it into an asset that the FAFSA will count against them.
In my next post, I’ll be sharing information about private college loans. Traditionally these loans have been designed for students with the parents cosigning. New private loans, however, allow parents to borrow exclusively.