Consumer Reports: ‘Why Parent PLUS Loans Can Be Costly‘ By Carla Fried, July 26, 2016
There may be better ways to help your kids pay for college
It’s not just young adults whose lives are on hold as they grapple with mountains of student loan debt.
Moms and dads across the U.S. are on the hook for more than $75 billion in Parent PLUS loans, the federal program that helps parents pay for a child’s college costs. That’s a steep 20 percent increase in just the past two years for what is a very expensive way to finance a degree.
A Parent PLUS loan can be used to pay for a dependent child’s expenses after other financial aid is exhausted. Like other federal student loans, it comes with some consumer protections, such as flexible payment plans. But the loan is solely in the parents’ name, so you are on the hook, not the student, if you have trouble paying.
For the 2016-2017 school year PLUS loans taken out by parents have a 6.31 percent fixed interest rate and there is also a 4.276 percent fee tacked on to that. So parents are paying more than 10 percent this year for a PLUS loan.
“There’s this perception among parents that the government is going to have the least expensive borrowing options, but that’s just not the case,” says Christopher McMahon, founder of McMahon Financial Services in Pittsburgh.
A quick course in smart strategies for family borrowing:
Focus on the big picture. Scott Moffitt, founder of Summit Financial Group in Loveland, Ohio, says a common mistake he sees families make is “they don’t think beyond the current year, or the current child.” He sits down with college-age families and estimates the potential total cost of sending all the kids to school, and if that entails borrowing, what the payments will be. “It’s not an easy conversation, but it’s an eye opener,” says Moffitt. The College Board has free online tools to help you estimate the cost of college, and the cost of borrowing for college.
One option for slashing the all-in cost is for a child to attend community college for the first two years, and then transfer credits to the in-state school. “You’re essentially getting the same education for 30 or 40 cents on the dollar,” says Moffitt. “And it’s not as if your degree will come with an asterisk that the first two years were at a community college.”
Kids first. Before any parent considers borrowing a penny for college, having the student first take out federal Stafford loans, “is a no brainer” says Moffitt, as borrowing costs are about half that of PLUS loans. All undergrad students are eligible for unsubsidized Staffords; the interest rate this year is 3.76 percent and the loan fee is 1.068 percent. The loan limit for the first year of college is $5,500, rising to $7,500 for the fourth year. Total borrowing for undergraduates is capped at $31,000.
Consider dipping into home equity. With home values rebounding strongly and lenders more eager to make deals, tapping some home equity can be more cost effective than PLUS loans. Bankrate.com reports that a $50,000 fixed-rate home equity loan currently has an interest rate below 4.5 percent. That’s nearly two percentage points less than the PLUS rate, and home equity loan closing costs, if any, are likely to be far less than the 4.276 percent fee that come with PLUS loans.
While a fixed-rate home equity loan immunizes the borrower from any future rate changes, Fred Amrein, a Philadelphia-area financial planner who specializes in college financing notes that for families applying for financial aid, a variable-rate home equity line of credit (HELOC) may be the better way to go. “Once the home equity loan is disbursed, any unused portion will show up as an asset on the next year’s aid application.”
The risk of the HELOC is that interest rates, which have defied expectations and stayed near historic lows for seven years, will begin to rise. If you don’t have emergency funds or other assets you could use if the HELOC rate becomes onerous, you might want to instead consider a cash-out refinance into a new 30-year mortgage. You refinance an amount that is more than you currently own and pocket the difference. While there will be closing costs with a new mortgage, the current 3.4 percent fixed rate is nearly half the rate of PLUS loans.
Of course, home equity should be tapped with great care. As strong as home values are today, you don’t need a long-term memory to remember when that wasn’t the case. To protect yourself from periods when home values may fall, McMahon advises to keep your total home loan borrowing (to no more than 60 percent of the home’s value. “That 40 percent equity is a smart cushion.” For the 50-somethings out there, make it your goal that you will only borrow a sum you can afford to pay back before retirement.
Make it a family affair. If your parents (the grandparents of your college bound kid) have ample assets, ask them if they’d like to become college loan officers. Assuming you’re on good terms, they are not going to charge you anywhere near 10 percent to loan you money. Moreover if you fall behind repaying the loan, you don’t have to worry about having your parents garnish your wages, or Social Security retirement benefit; with PLUS loans both options are within the government’s right to get repaid.