MONEY Ask the Expert

Avoid the Parent Trap: Why a PLUS Loan Isn’t the Best Way to Pay for College

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Robert A. Di Ieso, Jr.

Q: Would it be more beneficial to take out a Home Equity Loan versus a Parent PLUS to pay for a child’s college education?
—Lou M., Brooklyn

A: PLUS loans should be your last resort.

Sure, these federal loans allow parents to borrow up to the total cost of their child’s college education, minus any other aid the student may be receiving. But that’s where the good news ends: PLUS loans currently carry a 6.41% rate, and without Congressional intervention, that rate will jump to 7.21% come July 1. Plus, these loans also come with an “origination” fee of about 4.3% of the principal amount you borrow.

Additionally, the credit standards required for PLUS loans have gotten tighter in recent years, notes Fred Amrein, a financial planner who specializes in college funding, financial aid and student loan repayment. (Though there is one upside to this: If you’re denied a PLUS loan, your child can receive additional student loan money above the standard limit.)

Rather than you taking on a PLUS loan, Amrein advises pushing your child to take out the full amount they can in federal student loans—$5,500 to $7,500 annually for dependent students whose families weren’t turned down for a parent PLUS loan.

The interest rates for student loans are significantly less: After July 1, they will be 4.66% for subsidized and unsubsidized federal direct undergraduate loans and 6.21% for direct unsubsidized graduate loans. These loans have lower fees, too—about 1.1%. Students also aren’t subject to a credit check as parents are.

Students also have more flexibility with their repayment plans if they can’t keep up with payments than parents have with PLUS loans, says Amrein. And student loans can be forgiven or reduced through the teacher or public service loan forgiveness programs. Parents who take out PLUS loans can only have their loans discharged if the child dies, or if the borrower dies or becomes totally and permanently disabled.

Don’t want your child to be burdened with debt? You can treat the student loan in the same way as the PLUS—and you simply pay the bills for your kid.

If you need additional funds above the student loan limit, home equity financing is probably your next best move. Via a home equity loan or line of credit, you can borrow up to 85% of the equity in your home, with fees similar to those you paid when you financed your original mortgage. And in either case, up to $100,000 of interest you pay on home-equity debt is tax-deductible.

A home equity line of credit will have a lower initial cost of money than a home equity loan, but both have some drawbacks.

With a loan you are borrowing a single lump sum, usually at a fixed interest rate—currently averaging 6.22%, according to Bankrate. You’ll have to know upfront how much you’ll likely need to fund your child’s entire college education, since you probably won’t be able to take out a new home equity loan each year they’re a student. Also, once you have the loan, that amount becomes an asset and can reduce the amount of financial aid your child qualifies for by thousands of dollars, says Amrein.

A line of credit is similar to a credit card, allowing you to draw from a line in smaller sums as needed, up to a certain fixed amount. HELOCs typically only require you to pay interest for the first several years and have an average interest rate of 4.9%. But that rate is variable, meaning your monthly payments can change during the course of your repayment period. Borrowers should be prepared for their rates to rise since interest rates currently remain near historic lows.

Because you are borrowing smaller sums over time and using those to immediately pay bills with a HELOC, the money is not viewed as an asset and won’t affect financial aid awards. But because these loans are variable, they’re considered a little riskier since your interest rates could rise over time, though they do have set lifetime caps of—gulp!—18% in most states.

 

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