The first bill has arrived, and suddenly, it’s time. Your student is going to college and you’ve got to figure out how to finance it.
When it comes to education financing, a family’s first choice should always be the federal Direct Subsidized and Unsubsidized Loans. These are low-cost, fixed-rate loans (the rate for loans borrowed this year will be 3.76%), and the most that a dependent undergraduate student can borrow is $27,000 over the course of four years. The good news is that this loan is in the student’s name alone and your student will be solely responsible for repayment.
But what if you need more than what the federal Direct Loan offers? In addition to home equity and any other personal financing that may be available to you, there are two choices for education financing:
- The federal Direct PLUS Loan, which allows a parent to borrow as much as they need on behalf of their dependent undergraduate student, or
- A private educational loan, offered through a variety of lenders. For most of these loans, the student is the borrower, and a co-signer is required if the student doesn’t have established credit or sufficient income to qualify on their own. Generally speaking, a traditional undergraduate student who does not work full-time will need a co-signer. There are also several states that provide education financing to state residents or to students who attend college in their state. While some state programs have terms that are more advantageous than private loans, this is not always the case. For purposes of this blog post, we’ll treat state loans as private loans. (You can check with the state higher education agency in your state or in the state your child will attend college to learn more.)
When you are choosing between a PLUS Loan and a private (or state) loan, what should you consider? Here are four important questions to ask:
How easily can I be approved?
- The PLUS Loan is fairly easy to receive: A credit report is pulled, and the criterion for approval is simply the absence of adverse credit history (e.g., a recent bankruptcy, or delinquencies of more than 90 days). There is no review of your FICO score or debt-to-income ratio.
- Private and state loan approval criteria vary by program, but will generally include a favorable debt-to-income ratio and FICO score. The strength of the co-signer’s credit will often determine the price of the loan.
What is the cost of the loan?
- The PLUS Loan has a fixed interest rate, which is established by the government every spring, based on the yield of the 10-year Treasury note plus a fixed percentage. The rate is set on July 1 for loans borrowed in the upcoming year. The 2016-2017 PLUS loan rate is 6.31% (the two most recent years’ have been 6.84% and 7.21%). There is also an up-front (deducted from the proceeds) origination fee of 4.272% for loans with a first disbursement prior to October 1, 2016 (after that date the fee increases to 4.276%).
- Private loan interest rates and fees will vary depending on the program and on the credit-worthiness of the co-signer. Co-signers with excellent credit may be able to find a private loan with terms that are more favorable than the PLUS Loan. However, remember that college is a multi-year endeavor, and this may not remain true for all four years. As you co-sign new loans each year, the cost of each loan may increase as your debt-to-income ratio increases (not to mention market changes that affect how lenders set interest rates).
What are the repayment terms and how flexible are they?
- The Parent PLUS Loan has a ten-year repayment plan, but if you borrow more than $30K, you can get much longer than that to repay. This can make your monthly payments more affordable. Also, federal loans have provisions that allow you to temporarily delay payment if you are experiencing hardship, without affecting your credit rating. And finally, if you use the federal consolidation loan program, you are also able to take advantage of the Income Contingent Repayment plan, which keeps your payments at a reasonable percentage of your discretionary income.
- Private loan repayment terms are generally less flexible and provide few to no options for temporarily stopping payments when the borrower and/or the co-signer are experiencing personal financial difficulties. Be sure to read the promissory note carefully, and fully understand the repayment options that are available before you sign on the dotted line.
What happens if the borrower, the co-signer, or the student dies or becomes totally and permanently disabled?
- While this is a morbid question, it’s an important one. If the borrower or the student passes away or becomes totally and permanently disabled, a PLUS loan is forgiven by the federal government. This forgiveness is not considered a taxable event for the survivor.
- Read and understand the terms of any private loan carefully. Some lenders do provide insurance in the event of the demise of the student and/or the co-signer. Others do not. Even when insurance is provided, though, it’s likely the IRS (and possibly your state) will consider the canceled loan a taxable event for the surviving borrower or co-signer. Plan accordingly.
One more note about private loans:
Some lenders offer a “co-signer release” after the borrower makes a certain number of “on-time payments.” While this sounds promising, read the fine print. It is generally not an automatic release, and the borrower has to qualify for the loan on their own merit at the time the co-signer is released. This means the borrower will need a strong credit score and sufficient income to manage repayment of this and all other debt and expenses. Depending on how much has been borrowed, this can be difficult for someone who has only been out of college for a few years. If you plan to co-sign a loan for your student, know that you will likely be a co-signer until the loan is fully repaid.
Sifting through the variety of financing options available for college can seem daunting, but due diligence will be rewarded later with repayment terms that are manageable and affordable. Most college financial aid office websites will provide some information about PLUS Loans and private and state loans, and there are countless repayment calculators available to help you and your student figure out what is a reasonable amount to borrow (we like the College Board’s set of tools). Good luck!