Many times when students get their financial aid packages, there's a gap between what a student receives in financial aid (including federal student loans), and what is left over to pay. This can leave many students and families scratching their heads and wondering how to come up with the difference.
It's not an easy calculation — sometimes a family might have an asset they can tap into, like a college savings plan or home equity. Sometimes the family may be able to pay out of pocket outright or through a payment plan from the school. And sometimes, parents turn to loans. These loans can be private loans, but there's also a federal loan open to parents called the Parent PLUS loan (also known as Direct PLUS). Parent PLUS loans can be a good financing option for those who need upfront liquidity, but there are some features to be aware of before deciding if it's the right option for you.
What is a Parent PLUS loan?
A Parent PLUS loan is a federal education loan that is borrowed by the parent of an undergraduate dependent student. As a rule of thumb, most students are considered dependent for financial aid purposes until they turn 24 (read more about dependency status here).
Unlike federal education loans made directly to students, Parent PLUS loans have no cap — they can be borrowed up to the full cost of attendance of the college or university. Cost of attendance includes tuition and fees, room and board, books and supplies, travel expenses, etc.
How is a Parent PLUS loan different from a federal student loan (Stafford, Direct Subsidized/Unsubsidized, Perkins)?
While many features of the federal Parent PLUS loans are similar to federal student loans, there are a few important differences. First, parents must undergo a credit check to make sure they don't have an adverse credit history. Students don't have to go through a credit check for their federal student loans because the assumption is that the education they receive will help them earn more and ensure they will be able to pay the loan back. It’s not the same for parents whose future income is likely to be unaffected by sending their child to college.
Second, the interest rate is higher on Parent PLUS loans. Currently, interest rates on federal student loans are between 4.66 and 6.21%. A Parent PLUS loan has an interest rate of 7.21%, plus a 4% origination fee. Third, the Parent PLUS loan is technically not eligible for any income-driven repayment plans (though if consolidated into a Direct Consolidation Loan, it may qualify for Income-Contingent Repayment).
Additionally, the loan can never be transferred to the student — the loan is technically the sole responsibility of the parent, even though many families work out agreements to have the student pay the loan back.
Should I take out a Parent PLUS loan?
Like all loans, it depends. If a family needs the front-end liquidity that a Parent PLUS loan offers, it may be a great option. As a federal loan, there are some protections built in: disability discharge, cancellation upon death of either the student or parent, and a locked-in interest rate.
But an important factor to keep in mind is that while parents undergo a credit check approval process, the Department of Education does not make their decision based at all on a family's ability to repay the loan. This means that if some parents aren't careful, they could end up borrowing much more than what they would be able to realistically pay back. This is a problem because although federal loans have many protections in place that make them ideal, if you default on a federal loan, your wages could be garnished, any tax refunds could be seized, and eventually upon retirement social security could be garnished. It will also blemish your credit.
If you are considering a Parent PLUS loan, understand what your monthly repayment options will be on the debt that you are looking to take out. The Department of Education has some calculators that can be helpful. As much as possible, try to project what the total debt will be for the entire degree your student is seeking. Develop a budget to see if the monthly payment is affordable. And most importantly, have a frank discussion with your child about what you can afford to pay.