How Do Parent Student Loans Work?

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The rising cost of a higher education and growing concern over student loan debt have prompted many parents to explore the possibility of taking out loans to help their children pay for college. Their two main options are parent PLUS loans issued by the federal government and private student loans issued by banks and credit unions. Here's an overview of how parent student loans work and the pros and cons of each.

How Does a Parent PLUS Loan Work?

A direct PLUS loan is an education loan provided through the U.S. government and designed to supplement other forms of college financial aid. Direct PLUS loans are available to graduate students and to the parents of undergraduate students; a direct PLUS loan issued to parents is known as a parent PLUS loan. Qualifying parents can borrow up to the full cost of attending school, including tuition, room, board, books and other expenses, less any financial aid the student gets.

You are eligible to get a parent PLUS loan if your child (or, in certain cases, your stepchild) will be enrolled at least half-time in a college or university, and has applied for and accepted all financial assistance available through the Free Application for Federal Student Aid (FAFSA) form.

Parent PLUS loans are fixed-rate loans with relatively high interest rates. Each year on July 1, the government publishes the direct PLUS loan interest rate that will apply for one year. The current rate of 7.6% for 2018-2019 increased from the 2017-2018 rate of 7%.

One reason for the relatively high interest rates on parent PLUS loans is their relatively lax credit requirements. There is no minimum credit score needed to get a parent PLUS loan; you need only show that you do not have an "adverse credit history." Your credit history is considered adverse if your credit report shows any of the following:

  • Accounts with a total outstanding balance greater than $2,085 that are 90 or more days delinquent as of the date of the credit report, or that have been placed in collections or charged off in the two years preceding the date of the credit report.
  • A determination of loan default, discharge of a bankruptcy, repossession of a car or other assets for nonpayment, or property foreclosure in the five years preceding the date of the credit report.
  • Any charge-off or write-off of federal student aid debt in the five years preceding the date of the credit report.
  • Garnishment of your wages to satisfy an unpaid debt during the five years preceding the date of the credit report.

Even if you have adverse credit, you may be able to get a parent PLUS loan by completing an online credit counseling program and doing one of the following:

  • Getting someone without adverse credit (other than the student whose education is being financed) to endorse the loan by agreeing to pay it if you fail to.
  • Showing that adverse events on your credit report were the result of certain extenuating circumstances.

Either way, and with a parent PLUS or private student loan, it's a good idea to know where your credit stands. Get a copy of your credit reports and scores before you start the process.

Parent PLUS Loan Payment Options

The standard repayment term on a parent PLUS loan is 10 years of fixed payments. Parents may also request a 10-year graduated repayment schedule, which starts with smaller monthly payments and increases the payment amount every two years until the loan is paid off. Parents who borrow $30,000 or more in PLUS loans can opt for an extended 30-year repayment schedule.

You have the option to begin making payments on a PLUS loan as soon as the funds are issued or waiting for up to three years after the student's graduation to begin paying back the loan. Interest accrues on the loan starting on the day the funds are issued, however, so deferring the start of payments, using graduated payments and extending the repayment period all increase the overall cost of the loan.

In addition to the interest charges associated with your loan, parent PLUS loans carry an origination fee, calculated as a percentage of the total loan amount. The current fee percentage is just under 4.25%. This sum is commonly rolled into the monthly loan payment schedule. Using the fee and interest rates currently in effect, that means you'll be charged 7.6% interest on 104.25% of the amount you borrow, starting the day the loan is issued.

If it turns out that you don't end up needing or using the full amount of a parent PLUS loan, and under certain other extreme circumstances, there are provisions for cancelling some or all of a parent PLUS loan.

How Do Private Student Loans Work?

A more affordable alternative to parent PLUS loans, especially for parents with good to excellent credit, are private student loans. These are a form of standard installment loan, similar to a car loan or mortgage, offered by banks, credit unions and some specialty lenders focused on education loans.

Because private student loans are issued by competing lenders, they are available with a wide variety of interest rates and fees. As with the mortgage market, some student loans carry fixed interest rates, while others use adjustable rates that change over time in sync with market indexes. As with a car loan or mortgage, lenders will review your credit, including a credit report and one or more credit scores before making a loan offer. Applicants with better credit will likely be offered better lending terms in the form of lower interest rates and fees than applicants with poorer credit.

As is always true when applying for a consumer loan of any kind, shop around for the best lending terms you can get. You can apply to multiple private student loan providers at the same time, and if it's done within a short period of time, your credit won't take a hit for each individual inquiry the lenders make.

Private student loans offer parents greater flexibility than parent PLUS loans in terms of sharing responsibility for paying the loan. Private student loan lenders typically give parents the option of assuming full responsibility for a loan or sharing responsibility with the student whose education is being financed by cosigning a loan.

With a cosigned loan, the student is considered the principal borrower, and the parents agree to pay off the loan if the student fails to do so. When applying for a cosigned loan, credit histories of the parent(s) and the student are considered in the application process.

How Do Parent Student Loans Impact Credit?

Parent student loans, whether issued by the federal government or a private lender, are significant debts, and mismanaging them can have serious credit consequences. Missed payments can quickly lower credit scores and defaulting can put severe black marks on credit reports that will discourage lenders from doing business with the parent and student for years to come—or charging high interest and fees and interest payments on any credit they are willing to extend.

One critical distinction of a cosigned private student loan is that failure to keep up with payments will damage the credit of parents and student alike, while with parent PLUS loans and private student loans issued to parents alone, only the parents' credit is at risk.

Considerations Beyond Credit

The rising cost of a college education means that a loan to pay for a four-year course of study (along with any graduate studies) can easily be comparable to a mortgage loan in terms of size, monthly payment and, potentially, the time required to pay it off. Before taking on a student loan to support a child, parents would be wise to consider the long-term effects that making loan payments—and not saving the money they're using for those payments— will have on their retirement plans.

If student loan payments prevent fully investing in 401(k) funds and other retirement vehicles, they could have negative long-term impact on family finances. If that's a concern, it'd be wise to consult with a financial expert to help determine the wisdom of taking out a parent student loan.

As long as it doesn't imperil your retirement or financial future, taking out a loan to help pay for your children's college education can be a great investment in their future, A parent PLUS loan is an accessible option for parents with marginal credit (but no major negative credit events in the past five years), but if you qualify for a private student loan, that'll likely be more affordable over the life of the loan.

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