Parent PLUS Loans can be a good alternative to private student loans because they offer more flexible repayment options. But the loans can be costlier than other options, and consequences are harsh for default, including the potential for wage and Social Security garnishment.
What Is a Parent PLUS Loan?
The Direct PLUS Loan is a federal student loan program. One type of PLUS loan is the Parent PLUS Loan, made to the parent or legal guardian of a dependent undergraduate student to help cover the cost of the student’s education.
PLUS loans are not made to grandparents on behalf of a student grandchild unless the grandparent is the student’s legal guardian.
How Parent PLUS Loans Work
Parent PLUS Loans have a fixed interest rate, and the borrower pays an origination fee for each loan. Parent PLUS Loans are not subsidized, so interest begins to accrue on the outstanding loan balance as soon as funds are disbursed and continues to accrue even if the loan is in deferment. There is no grace period for repayment. Unlike federal student loans, the borrower is expected to start making payments right away.
This is not a loan to the student. As Richard D. Gaudreau, a student loan attorney in New Hampshire, points out, “It is not a co-signed loan.” These credit-based loans are made to the parent alone.
Differences Between Parent PLUS Loans and Private Student Loans
Perhaps the most important distinction between federal student loans and private student loans is that federal student loan borrowers can take advantage of income-driven repayment plans, and private student loan borrowers cannot.
Another important difference lies in the lender’s collection options. “Federal loans can be harder to get rid of during bankruptcy,” says Gaudreau. In default, “the government can garnish your wages. They can take up to 50 percent of your Social Security. They can withhold your tax refund. They have more power to collect.”
Private student loan lenders do not have the same garnishment powers. “There is a statute of limitations on collection for private loans, but not on federal loans,” says Gaudreau.
One unique feature of Parent PLUS Loans is that they are forgiven if either the student or the parent borrower dies. Private loans are still collectible in the event of death. “In fact,” says Gaudreau, “the lender can go after the parent for a loan taken by the student.”
The main advantage private student loans offer is that they tend to come at lower interest rates than their federal counterparts. A borrower might see a difference of 2 percent or more, depending on his or her credit standing. Over the course of a 10-year or longer repayment period, the lower interest rate can add up to significant savings.
[Read: The Best Private Student Loans of 2018.]
Parent PLUS Loan Pros and Cons
Parent PLUS Loans are a great deal for the student and the school. The student gets help paying for his or her education without any obligation to pay the money back. Likewise, schools benefit when parents bridge the gap between what the student can pay and the actual cost of attendance. Since parents borrow directly from the government, the school does not suffer losses if the loans are not repaid. Some critics argue that schools have a financial incentive to encourage borrowing by parents.
The parent can borrow up to the cost of the child’s attendance each year, minus any financial assistance that has been awarded, with no limit on the amount borrowed. This is true regardless of the parent’s income. Although an unlimited loan source may seem appealing, there is real potential for the parent to get into heavy debt.
A disadvantage to parent loans, in general, is that you are taking on debt for someone else’s benefit, possibly at a time when it would make better financial sense to eliminate rather than add debt. Americans, in general, fall short on retirement savings goals. Many financial experts discourage jeopardizing your own financial stability in retirement to help a family member.
Kat Tretina, certified student loan counselor at StudentLoanHero.com, agrees. She is not a fan of the Parent PLUS Loan. “They can amount to a lot of debt that you have to repay and potentially risk your own retirement to do so.”
Parent PLUS Loan Repayment Options
Parent PLUS Loan borrowers will automatically be placed on a standard repayment plan when payments begin. To qualify for an income-driven repayment plan, Parent PLUS Loans must first be moved into a Direct Consolidation loan, a process Gaudreau characterizes as very simple. Then the parent can apply for the income-contingent repayment, or ICR, plan, which is the only income-driven repayment plan available to Parent PLUS Loan borrowers.
For a Parent PLUS Loan borrower who is at risk of falling behind on payments, the ICR plan can potentially lower the required monthly payment to an affordable level. Depending on your income, “you can get a payment as low as $0,” says Gaudreau.
Under the ICR plan, your required minimum payment will be the lesser of:
— 20 percent of your discretionary income.
— The amount you would pay on a 12-year fixed repayment plan, adjusted according to your income.
According to the Department of Education, for the ICR plan, discretionary income is the difference between your annual adjusted gross income and 100 percent of the poverty guideline for your family size and state of residence.
Gaudreau says that when he meets with borrowers who have run into trouble repaying their loans, the problems often stem from lack of information; they are unaware of their repayment options. “The parent may never have been told that the loan is eligible for ICR.”
Parent PLUS Loans have no grace period. Payments begin after the loan funds are disbursed. But a payment delay may be possible. Borrowers can request a deferment if the student is enrolled at least half-time and for six months following graduation. The borrower is responsible for the interest that accrues during deferment, by either making interest-only payments or by allowing the interest to capitalize.
[Read: The Best Student Loan Consolidation Lenders of 2018.]
Parent PLUS Loans are eligible for the Public Service Loan Forgiveness program, in which the remaining balance is forgiven after the borrower has made 120 qualifying monthly payments and the borrower is employed full-time for a qualifying employer.
“It’s not just for firefighters and police officers,” says Tretina. You can be eligible for loan forgiveness “in any role in a qualified nonprofit or government agency.” That means you can be employed as an accountant, secretary, driver or in some other job and be eligible for forgiveness if you work for a qualified employer.
For any borrower pursuing loan forgiveness, the government recommends that you certify your employment every year by sending in the required form for approval.
How Much Will I Pay for Interest and Fees on a Parent PLUS Loan?
The interest rate on a Parent PLUS Loan — 7.6 percent as of fall 2018 — is generally higher than the rate for a private student loan — around 5.25 to 6 percent.
“One of the biggest problems with federal student loans,” says Tretina, “is the higher interest rates. They’re not as high as credit cards, but over 10-20 years the interest can really make the balance balloon.”
The interest rate on a Parent PLUS Loan also may be higher than the rate on other possible sources of financing. For example, parents who are homeowners may be able to take a cash-out refinance mortgage at a lower rate.
Parent PLUS Loans also come with an origination fee — currently 4.264 percent — that is deducted before the loan is disbursed. That’s $426.40 out of every $10,000 borrowed. Interest will be calculated on the full amount borrowed, before the fee is deducted.
Can I Afford a Parent PLUS Loan?
The application for a Parent PLUS Loan is based on the borrower’s credit history; no loan officer will look at your income or other debt, or otherwise evaluate whether you can afford to make the payments. It is your responsibility to make sure you aren’t borrowing more than you can afford to pay back. Although the ICR plan is available on consolidated Direct loans, keep in mind that you’ll need to budget for 25 years of payments.
A Parent PLUS Loan may be best suited to someone who may not have enough assets to pay for a child’s education out of pocket but expects to maintain a steady income — such as a parent who is at least 25 years from retirement, or who is the beneficiary of a trust or other reliable, long-term source of income.
“Unless you can easily afford payments and/or have a plan to pay ahead of schedule, and you already have significant savings for retirement, you may not be a good candidate for a Parent PLUS Loan,” says Tretina. “Especially because with the Parent PLUS Loan, you could be risking your Social Security.”
[Read: Getting Student Loans Without a Co-Signer.]
The Parent PLUS Loan Application and Approval Process
A parent or legal guardian of a dependent undergraduate student can apply for a Parent PLUS Loan. You must have filled out the Free Application for Federal Student Aid, or FAFSA, for the academic year when you want to borrow. You may not have any adverse credit history, such as a bankruptcy or tax lien, within the past five years.
Each year, you can borrow as much as your child needs to cover the cost of attendance, minus the other financial aid that has been offered.
Is a Parent PLUS Loan Right for Me?
Arm yourself with information about Parent PLUS Loans and approach them with caution. The number of Parent PLUS Loan borrowers more than doubled from 1996 to 2016, and the average amount borrowed went up by a factor of 2.5 during the same period. About 41,000 Parent PLUS Loan borrowers saw their wages, tax refunds or Social Security payments garnished in 2015.
“Some parents may think it’s a loan for the kids,” says Gaudreau. “It’s not always crystal clear that the parent is the one who is liable for the loan.”
A great strategy for avoiding burdensome student loan debt is to find other ways to finance your child’s education. Tretina suggests that the parent help the child get all the free money possible. “Max out grants and scholarships before you take on any debt,” she says. “Many students pay for school solely with scholarships. It can be done.”
When free money options are exhausted, help your children apply for loans in their own names. Not only does this protect the parents’ retirement outlook by ensuring that they are not responsible for the debt, but the child will also get a much lower interest rate. Undergraduate Direct subsidized and Direct unsubsidized loans’ interest rates are currently 5.05 percent. And in the end, the children have more working years ahead of them than parents do.
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Everything You Need to Know About Parent PLUS Loans originally appeared on usnews.com
