What parents need to know before borrowing money to pay for college

A Direct Plus loan? Home equity? Parents should understand the pros and cons of all their loan options.

  • By Cheryl Winokur Munk,
  • The Wall Street Journal
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With college costs burgeoning, parents often consider taking on debt to help their children cover tuition. It could be a smart move. But it could also have a devastating financial impact, so parents should understand the pros and cons of each option.

Here’s a look at the choices out there and what parents need to consider before signing on.

Federal Direct Plus loans

One increasingly popular way for parents to help pay for college is a Direct Plus loan from the federal government. Graduate and professional students can use these loans, as well; when parents do, the loans are commonly known as Parent Plus loans.

During the application process, prospective borrowers go through a credit check; parents with an adverse credit history might still receive a Parent Plus loan by obtaining an endorser or documenting extenuating circumstances related to their credit history.

One appeal of Parent Plus loans is that they offer some consumer protections that don’t often exist with private loans. For instance, a parent who has difficulty repaying can consolidate the loan into a Direct Consolidation loan with the federal government to access an income-based repayment plan. It isn’t the most generous of the income-based repayment plans, but it is at least one safety net for parent borrowers, says Clare McCann, deputy director for federal policy at New America, a research organization that has studied the student-loan system.

Other possible options for debt relief with Parent Plus loans can include economic-hardship deferments; disability or death discharge; graduated or extended repayment plans; and Public Service Loan Forgiveness, a program that is available to eligible borrowers employed by a government or not-for-profit organization.

Be warned, though, that it can be easy to get in over your head with these loans. Parent Plus loans let you borrow up to the cost of attendance minus any other financial aid received, and the loans don’t take into account your ability to repay.

Parent Plus loans also carry higher interest rates and fees than other federal student loans. For instance, they have a fixed interest rate of 7.08% for loans taken out from July 1, 2019, to June 30, 2020. Parent Plus loans also carry an upfront loan fee of 4.24% for loans taken between Oct. 1, 2019, and Sept. 30, 2020.

There is no annual percentage rate provided on these loans. But free online calculators such as the Experian APR Calculator can help families calculate the APR and better compare the costs with loans from private lenders.

Finally, bear in mind that it is the parents’ responsibility to repay Parent Plus loans; they can’t be transferred to the student. Also, unless the parent requests a deferment, repayment is expected to begin after the loan is fully disbursed.

Private parent loans

Similar to a Parent Plus loan, a private parent loan is taken out in the parent’s name only. This loan type shouldn’t be confused with a private student loan, which is often cosigned by a parent.

Each loan offer should be weighed carefully, since every lender has different rates, perks and requirements, and some can have application, origination or disbursement fees. Parent borrowers may also be able to choose among different repayment plans, such as immediate repayment and interest-only repayment while the student is in school, depending on the lender. Parents can visit individual lenders’ websites for information on whether these loans might be available or use an online loan-comparison platform like Credible.

Be aware, though, that many private loans don’t have the same types of consumer protections that federal Plus loans offer. What’s more, because not all lenders offer parent loans, there is less of an opportunity than with private student loans to shop around.

As of Oct. 31, rates offered by three lenders that offer private parent loans on Credible’s marketplace ranged from a 4.79% to 12.12% APR for a variable-rate loan and 5.48% to 12.87% for a fixed-rate loan. By contrast, rates offered by the private student-loan lenders on Credible’s marketplace ranged from a 2.90% to 11.62% APR for variable loans and a 3.82% to 12.49% APR for fixed loans, as of Oct. 31.

Home equity

Another option is a secured loan, such as a home-equity line of credit or home-equity loan. With a home-equity line of credit, borrowers withdraw money as they need it, up to a certain amount. These loans often have a floating interest rate, and borrowers generally have 10 to 20 years to pay the money back. A home-equity loan, by contrast, is a one-time lump-sum loan that often comes with a fixed interest rate.

The interest rates on home loans may be more favorable than other types of loans for college—but before proceeding, parents need to consider factors such as their home’s value, how much they owe, how much they need, closing costs, whether there are prepayment penalties and whether they are comfortable putting up their home as collateral, experts say.

In addition, these loans have limited repayment options compared with other types of college loans, and the loans must be repaid if the home is sold. Another consideration for parents is that any unspent proceeds from a home-equity loan are counted as an asset on the Free Application for Federal Student Aid, or Fafsa—the government’s form for financial aid—which can reduce a student’s eligibility for need-based aid.

Finally, experts give one overall warning about taking out any type of loan to help pay for college: Parents need to consider their ability to afford repayments—especially if they are still paying off their own loans. In cases where parents have to take on heaps of debt to fund a child’s education—or incur any amount of debt they aren’t financially comfortable taking—it is generally better for the student to attend a less expensive college, experts say.

Parents shouldn’t bite off more than they can chew, says Cody Hounanian, program director at Student Debt Crisis, an advocacy organization for borrowers. “It’s coming from the right place,” he says. “However, obviously, there can be financial consequences.”

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