How Parents Can Borrow for College

Are you a parent who needs to borrow for college?

Most of the attention is focused on college loans that students take out, but there are parent loans as well.

In case you missed it, I wrote about federal student loans in my last college blog post:

What You Need to Know About Borrowing for College

Today, I’m going to focus on two ways that parents can borrow for college – the federal Parent PLUS Loans and home equity lines.

PLUS Loan

For  parents, the federal government offers Parent PLUS Loans. The PLUS is designed to allow parents to borrow to pay the costs that aren’t covered by a child’s financial aid package. So how much parents can borrow will depend on how much aid a student received in an aid package as well as how much the school costs.

The federal parent loan isn’t nearly as popular as the federal Stafford Loan for students and it’s easy to see why. Borrowers face an interest rate of 7.9% when obtaining a PLUS Loans and there is a 4% fee tied to the amount of the loan. In contrast, the interest rate on Stafford Loans are 6.8% – and, in some cases, 3.4%. As I mentioned in yesterday’s post, the 3.4% rate is scheduled to disappear unless Congress acts soon.

PLUS Loan Features

Here are more features of  the PLUS Loan:

1. The PLUS Loan comes with a fixed interest rate.

The interest rate of 7.9%, which hasn’t changed since 2006, is certainly high considering where interest rates are currently.

The official explanation is that the interest rate on these college loans is greater than you could get, say with a home equity loan, because there is no collateral. If you stop making payments on your mortgage, the lender has your house as collateral. If you stop making payments on your PLUS Loan, trust me bad things will happen, but no one will confiscate your kid’s college diploma.

When you consider how low interest rates are currently, there is little to no room for them to drop further. When interest rates do begin climbing, parents with a fixed rate loan could be glad they have one. In contrast, private college loans have no interest rate ceilings. I’ll be discussing private student loans in my next post.

2. Most parents will qualify for a PLUS Loan.

Your credit score doesn’t have to be good to qualify for a PLUS, but you can’t have certain adverse black marks on your credit history. For instance, you can’t be more than 90 days late on paying a debt and you can’t have had 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 Stafford Loan, which I wrote about yesterday.

By the way, PLUS loan obligations can’t be dismissed in bankruptcy court.

3. Everyone gets the same terms.

Everyone borrowing through a PLUS Loan  gets the 7.9% interest rate. That’s not the case for families using private loans. Private lenders will charge higher interest rates to families with lower FICO scores and will even base interest rate decisions on what schools students are attending. Families with excellent credit histories can get lower interest rates from private college loans.

Parents have the option to begin making PLUS loan payments right away or wait until their child graduates or otherwise leaves school.

4. The loan ceilings are higher.

Parents can borrow up to the cost of their child’s college expenses minus any financial aid that the family has received. Of course, that doesn’t mean parents should borrow that much. Please read:

 How Much Should Parents Borrow?

Home Equity Loan

If I ever have to borrow for college, I would tap into my home equity line of credit.  The interest rate on my line of credit through Charles Schwab is variable, but my loan is one percentage point below prime. It’s at a great rate – 2.25%. Anticipating college costs, I set up the HELOC when my daughter, who graduated from college in 2011, began high school. Admittedly, it was easier to get credit lines back then.

For many parents, their home equity line is going to offer a better interest rate and if you itemize on your taxes, the interest is deductible.

There are, however, three potential problems:

1. If you don’t possess a line of credit, you might not be able to obtain one now because of tighter loan underwriting.

2. You might not have any home equity!

3. Just like private college loans, the interest rates on these lines are variable. I don’t see inflation on the horizon — hasn’t been for years — but no one knows what will happen in the future.  It would be up to you to weigh the pros and cons of obtaining a fixed rate federal loan with a home equity loan or private college loan, which also routinely offer variable rates.

Lynn O’Shaughnessy is the author of the second edition of  The College Solution, which will be released May 6 and is available for preorder on Amazon.