Derenda King, CFP®/CDFA®
A growing number of families who are faced with high college prices are turning to federal PLUS loans to cover the cost of a bachelor’s degree. At the same time, families are also struggling to repay this debt.
Most of the attention on the issue of college borrowing focuses on student loans—and it is true that student loans represent the vast majority of federal college debt. However, I wanted to take a moment to shed more light on the facts, pros, and cons of family-held PLUS loans. Here are a few points families should be aware of before they sign on the dotted line:
The Parent Loan for Undergraduate Students (PLUS) loans enable parents of dependent undergraduate students to borrow to pay for college costs not covered by financial aid. The student has to be enrolled at least half-time in an eligible program to be eligible to open an application for a PLUS loan.
To apply for a PLUS loan, the student must first complete and submit the Free Application for Federal Student Aid (FAFSA). This is a universal requirement for financial aid programs anyway. The Federal Student Aid office will use the information from the FAFSA to determine your family’s level of financial need and your eligibility for a PLUS Loan. If they tell you that you are eligible, you must then complete the Direct PLUS loan application and the Master Promissory Note, which describes the terms and conditions for repaying the loan.
As mentioned above, the child must be a qualified undergraduate student and a dependent. Additionally, parents must meet the following criteria:
- They must be the biological or adoptive parent of the student (in some cases, the stepparents can also qualify)
- They must pass a credit check
You don’t necessarily need excellent credit, but you can’t have an adverse credit history. If parents don’t have an adequate credit history, they could still qualify if they submit a successful appeal for an exceptional circumstance or have an endorser, which acts like a cosigner. There are no income limits.
Parents can borrow up to the full cost of attendance at their child’s school minus any financial aid their child is awarded each year. For example, if the cost of attendance is $60,000 and the student receives $30,000 in financial aid, then the maximum that the parent can borrow is $30,000.
Although PLUS loans can be a useful financial tool for many parents, they come with both pros and cons. Here are some factors to consider:
- Your interest rate will stay fixed over the life of the loan. Once parents borrow the loan, it has a fixed rate that stays the same throughout the life of the loan. The interest rate is set annually for new loans that are made between July 1 of one year and June 30 of the following year. For examples, the fixed rate as of July 1, 2020 is 5.30%. Note that these rates are higher than any other type of federal loan. By comparison, the current interest rate for the undergraduate direct student loan is 2.75%. This is why it’s best for the child to exhausts their personal eligibility for student Direct Loans before applying for a PLUS loan.
- Forbearance and deferment options are available. PLUS loans have federal protections in the form of a forbearance or a deferment. The forbearance option is available to those who experience an illness or financial hardship. This enables you to skip a few payments, temporarily make smaller payments, or extend the length of time to repay the loan. A deferment or temporary postponement is available to PLUS loan borrowers of current undergraduate students. However, with both options, interest continues to accrue during the period of the deferment, which means borrowers will owe more once they commence repayment.
- Flexible repayment plans are available. PLUS loan borrowers can qualify for different payment plans. These include the following repayment options: (1) Standard payments (fixed monthly payments over 10 years), (2) Graduated payments (payments start small and gradually increase over 10 years), and (3) Extended payments (fixed or graduated payments for up to 25 years). These flexible repayment plans can be a lifesaver for those who lose their job or experience financial hardship.
- There are additional fees for taking out the loan. PLUS loans come with an origination or disbursement fee, on top of the interest. Loans disbursed after October 1, 2020, will be assessed an origination fee of 4.228%. For example, if you borrowed $30,000, you’d pay an origination fee of $1,268.40. This extra fee is a considerable expense when you realize that it’s in addition to the interest you’ll be paying.
- You are expected to start repayment right away. Along with the origination fee, parents must start making monthly payments within 60 days of full disbursement unless they request a deferment.If a deferment is granted, it’s important to remember that interest will continue to accrue during that time.
- Loan repayment cannot be transferred. Parents generally cannot transfer the responsibility of repayment to their child, which means that they can be stuck paying for the loan for over 20 years. This can be problematic if parents hit retirement while they are still repaying the load, which could make the debt unaffordable. In addition, PLUS loans are rarely discharged.
- High risk. Although PLUS loans can be a useful option for parents looking to help their children pay for college, they generally are not the best option for everyone. Loose borrowing limits, higher interest rates, and few options for loan forgiveness make these loans a risky option for families.
The average annual amount that parents borrow has increased from $5,200 in 1990 to $16,100 in 2020. This is pretty much in line with college cost inflation, but nearly nine percent of parents entering into repayment owe more than $100,000! Since parents can borrow enough money to meet the cost of a school’s attendance that isn’t covered by their child’s financial aid, it ultimately makes it very easy for them to over-borrow and end up with unmanageable debt. Thus it’s imperative for parents to do their research and make sure they know every detail and consider other options before taking out a PLUS Loan. For more information, visit the Federal Student Aid website.