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Is There a Better Option for Financing a College Education than a Parent PLUS Loan?

Mark Kantrowitz

November 19, 2012

I have a simple question: Is there currently a better option to help finance my sophomore daughter’s college education than a 7.9% PLUS loan? That just seems a bit high given the current economic environment? — Alan S.

When considering how to finance a college education, there are many options, including federal education loans, private student loans and non-education loans. It is important to carefully weigh the costs, benefits and risks of each option. These include the interest rates and fees on each loan, whether the interest rate is fixed or variable, when repayment begins, repayment plans, options for dealing with financial difficulty and the consequences of default.

Federal Education Loans

The Federal Parent PLUS loan is borrowed by parents of dependent undergraduate students. It has a 7.9% fixed rate with 4% fees. The annual limit is up to the full cost of attendance minus other aid received, with no aggregate limit. Payments on the Federal Parent PLUS loan can be deferred while the student is enrolled on at least a half-time basis and for six months after graduation.

Eligibility for the Federal Parent PLUS loan does not depend on financial need, so even wealthy parents may borrow from the Federal Parent PLUS loan program. There is a modest credit check that looks for adverse events in the borrower’s credit history, such as delinquences, defaults, bankruptcy discharge, foreclosure and repossession. The credit check does not, however, consider credit scores or debt-to-income ratios.

The Federal Stafford loan is borrowed by students, not parents. It is a less expensive option, but it has lower loan limits. The Federal Stafford loan comes in two versions, subsidized and unsubsidized. Eligibility for the subsidized loan depends on financial need, while the unsubsidized loan does not. Neither version involves a credit check, so even a borrower with a bad credit history can qualify. The federal government pays the interest on subsidized loans during deferments, such as during the in-school deferment and the economic hardship deferment. The Federal Unsubsidized Stafford loan has a 6.8% fixed rate with 1% fees. The Federal Subsidized Stafford loan has a 3.4% fixed interest rate, but this interest rate is likely to increase to 6.8% for new loans made on or after July 1, 2013. Overall annual limits for the Federal Stafford loan vary by year in school from $5,500 for freshmen to $7,500 for seniors, with limits that are $4,000 to $5,000 higher for dependent students whose parents were denied a Parent PLUS loan and for independent students.

Repayment options for Federal Stafford and PLUS loans include standard repayment (10-year term), extended repayment (10 to 30 year terms based on the loan balance) and graduated repayment (payments increase every two years). Income-based repayment is available for federal student loans but not federal parent loans. (Income-contingent repayment, a predecessor of income-based repayment, is available for Federal Parent PLUS loans that have been consolidated into the Direct Loan program, if the parent did not enter repayment prior to July 1, 2006.) Income-based repayment is a safety net that bases the monthly payment on a percentage of the borrower’s discretionary income, not the amount owed. Federal student loans offer forgiveness for borrowers who work full-time in a public service field while repaying their loans under income-based repayment in the Direct Loan program.

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