During the summer months, college-bound students and their parents will pay their first tuition bill for the fall semester. Seeing the amount due can be a harsh dose of reality, especially since they may have to multiply it by four years and the number of children in the family.
Even after financial aid, families often face a tuition gap. To cover it, many parents take on debt.
According to Sallie Mae’s annual “How America Pays for College” report, in families that borrow to pay for college, parents take out loans 35 percent of the time. As a result, federal p arent PLUS loan debt equals more than $75 billion — and that doesn’t account for private loans that parents borrow.
[Parents think hard before borrowing for or with their student.]
Taking on long-term debt can have a big impact on parents’ other financial goals, especially as they near retirement. Before you borrow for your student, understand what you’re getting into with these different funding options.
— Parent PLUS loans: Sometimes, schools include parent PLUS loans on award letters to cover tuition gaps. That doesn’t mean you have to use this funding option or that you will even qualify for it, since you’ll need good credit. However, if you do qualify, these federal loans generally present the safest option for borrowers.
As federal education loans, parent PLUS loans come with better repayment options than other private loan options. These benefits include more generous repayment, postponement and forgiveness options than most private loans. In addition, PLUS borrowers can consolidate these loans to take advantage of income-contingent repayment.
ICR bases your monthly payments on your income and family size, capping these amounts at 20 percent of your disposable income. After 25 years — 10 if you work for a public service or nonprofit employer — the remaining balance is forgiven.
That amount is taxable under the income-contingent repayment plan unless you obtain forgiveness under Public Service Loan Forgiveness first. Still, having lower payments could benefit you greatly if repayment stretches into your golden years.
[Discover four things borrowers don’t always know about parent PLUS loans.]
— Private student loans: It’s almost always better to borrow federal loans before private loans, largely due to the previously mentioned benefits. But to cover a tuition gap, parents may also borrow a private student loan or co-sign a private student loan with their child or another borrower with good credit. And while co-signing may seem like less of a commitment, it really isn’t.
As a co-signer, you bear equal responsibility for a student loan. Your child may agree to make all the payments, but if he or she doesn’t, you will be on the hook for that money — and your credit score and overall financial situation will suffer due to the delinquency or default. Another credit issue to note is that co-signing a private student loan and borrowing a federal parent PLUS loan will affect your debt-to-income ratio the exact same way.
The biggest benefit to private student loans is typically lower costs. Their advertised interest rates can be much lower than PLUS loans’ rates. However, you may not actually qualify for those low rates — they’re typically reserved for borrowers with excellent credit, and you may be unable to lock them in.
PLUS loans use a fixed interest rate. Currently, this is 7 percent. With a fixed rate, you’ll know exactly what you’ll owe each month and how that may fit within a fixed income during retirement.
[Ask these 10 questions before borrowing a private student loan for college.]
— Home equity loans: Home equity loans are private loans in which homeowners take out a line of credit against the value of their homes beyond what they owe on their mortgage. For example, if your home is worth $180,000 and you owe $150,000 on your mortgage, the equity you could borrow would be $30,000.
Like with other private loans, parents who opt for home equity loans typically do so based on cost. Interest rates on these loans vary depending on different factors — your credit, your home’s location — but are typically around 5 percent. PLUS loans also include a 4.264 percent origination fee, which home equity loans rarely charge, and they offer a smaller paid interest deduction on your taxes than home equity loans: $2,500 versus $100,000.
Those are big benefits, but home equity loans have the biggest downside, too. In short, when you borrow a home equity loan, you essentially put your home up as collateral. If you don’t repay the loan, your lender can repossess your house. Defaulting on a federal student loan comes with serious consequences — but losing your home isn’t among them.
Which of these loans is right for you? Ideally, none of them. Before you take on any debt, have your children max out his or her own loans. You may not want to saddle your child with loans, but he or she has many more years of income to repay them than you will.
Bottom line: Your child’s college dreams coming true shouldn’t mean a financial nightmare for you.
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3 Student Loans for Parents to Fill a College Tuition Gap originally appeared on usnews.com
