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.
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.
I would like to take a Parents Plus loan for my daughters education which she will be responsible to pay back. Will this loan have an impact on my FICO score? Will it affect my debt/income ration in regards to being approved for something like a car loan???
You can’t saddle your daughter with a Parent PLUS loan. You are the one legally responsible for this loan. Only you would sign for this loan. I assume it would impact your credit score depending on how much you borrow.
Does it make sense if my cash flow allows me to pay for my child’s college out of my monthly income to pay it or to take a loan out and take the difference of the money and invest it?
In other words if I can afford $3000 a month towards college should I do that or take a loan out and take the difference and invest it for a greater return.
It’s far better to pay for your child’s education out of your monthly income! I say this as a financial journalist.
What do you think about refinancing my mortgage and getting cash out? I have 6 years left on my mortgage. I can get a 10 year 3.0% refi and end up paying about $200 more than my current mortgage payment. Seems way better than 7.9%. . I am not sure exactly where to put the cash until she needs it so that it doesn’t count against us on the FAFSA – whole life insurance is one idea I’ve seen.
I was thinking the same thing as Lucy i have 3 a senior a junior and a 9th grade. I wanted to do a re-fi an put cash into their 529’s or in one of my accounts and just start paying one loan with todays low rates. They can’t stay this low forever.
I understand that there is a cost to taking the money out too early that is why many use a HELOC.
How will taking the cash out impact the FASFA? Is there an easy calculator I can use? We make too much so we are only getting the 5500 Stafford but I want the kids to take those out on their own so they have a stake in the finanances.
Thanks in advance
Taking the cash out of your house is a bad idea if you hope to receive need-based aid. Whether you receive need-based aid will depend upon your Expected Family Contribution. You can use a EFC calculator to determine what that figure is.
The FAFSA does not ask about home equity, but if you pull your money out it is fair game. The FAFSA formula would access this money at 5.64%. So pulling $75,000 out of your house, for instance, would increase your EFC by $4,230.
I would suggest that you use a home equity line of credit instead.
Thanks for the reply Lynn. A very informative site.
I took out a HELOC eight years ago when my first daughter had graduated HS. I didn’t like the rates on any of the school
loans, and didn’t want to have to pay interest on an entire Home Equity loan amt. of $50,000. I wanted to borrow money as I needed it and pay it back as quickly as I could, paying interest only on the amt. owed. The interest rate has been variable, but dropped to 2.75 years ago and has stayed there ever since. I get to deduct it on my taxes and it helped 2 daughters through college . The 2nd graduated two years ago and now my 3rd child will be starting in the fall and I’ll have $43,000 available to borrow at that point. It has worked very well for me.
For any parent taking out large loans or co-signing on a child’s large loan: Get life insurance on your child that will pay off the loans if something horrible happens. Term life insurance on young people is cheap.