Is There a Better Option for Financing a College Education than a Parent PLUS Loan?
November 19, 2012
Both the Federal Stafford and PLUS loans offer a variety of options for borrowers who encounter financial difficulty. Payments may be suspended using the economic hardship deferment for up to 3 years and forbearances for up to 5 years. Interest, however, will continue to accrue on unsubsidized loans during a deferment and on both subsidized and unsubsidized loans during a forbearance. Accrued but unpaid interest will be capitalized, which adds it to the loan balance. These loans may also be canceled if the borrower dies or becomes totally and permanently disabled.
The optimal strategy from a cost perspective is to have the student borrow from the Federal Stafford loan first. Only if the student has exhausted the Federal Stafford loan limits should the parent consider borrowing from the Federal Parent PLUS loan.
There’s also the Federal Perkins loan, which is currently a subsidized loan with a 5% fixed interest rate. Funding for this loan program is limited, with loans awarded by the college financial aid office. President Obama has proposed expanding the program from $1 billion in loans a year to $8.5 billion, but the expanded loan program would offer unsubsidized loans with a fixed 6.8% interest rate.
Private Student Loans
Private student loans include non-federal loans from commercial lenders and from non-profit state loan programs. Most interest rates on private student loans are variable, although some lenders have started offering fixed rates with short repayment terms. More than 90% of new private student loans require a creditworthy cosigner. (A cosigner is a coborrower, equally obligated to repay the debt.) Interest rates are usually based on the borrower’s credit scores and the credit scores of the cosigner. Very few borrowers get the lender’s lowest interest rate; the majority get the highest interest rate. Repayment terms are less flexible than the federal education loans.
There are also a variety of non-education loans, such as home equity lines of credit (HELOC), home equity loans and credit cards. Repayment on these loans begins immediately. These loans usually do not offer deferments, forbearances, loan forgiveness or flexible repayment plans. The monthly payment on a credit card is usually a percentage of the outstanding balance, yielding a higher initial minimum monthly payment that decreases over time.
Loan Interest Deductions
Up to $2,500 in interest paid on federal and private student loans is deductible on the borrower’s federal income tax return as an above-the-line exclusion from income. The taxpayer does not need to itemize to take advantage of this student loan interest deduction.
Interest paid on up to $100,000 in principal on a home equity loan or HELOC is also deductible, but only if the taxpayer itemizes. This deduction may be limited if the taxpayer is subject to the Alternative Minimum Tax (AMT).