What Are the Tradeoffs of Federal and Private Loans for Parents?
When it comes to financing college costs, it’s important to find the right loan. After the student has exhausted the Federal Direct Stafford loan limits, there are several borrowing options available to parents, including Federal Parent PLUS Loans, private student loans and private parent loans. What are the pros and cons of these loans?
Federal Parent PLUS Loans
Federal Parent PLUS loans are made by the federal government to parents of dependent undergraduate students. The student is not obligated to repay the debt.
One advantage of federal student loans is their fixed interest rates. The fixed interest rates on Federal Parent PLUS loans are often lower than what you might find on a typical private loan. The interest paid on a Federal Parent PLUS loan also qualifies for the student loan interest deduction, further reducing the cost of the loan.
Like federal student loans, Parent PLUS loans have lower eligibility requirements than private loans. However, the Free Application for Federal Student Aid (FAFSA) is a prerequisite for federal education loans. Also, the parent’s credit history does come into play, and could affect eligibility if they have an adverse credit history. But, eligibility for the Federal Parent PLUS loan does not depend on the borrower’s credit score or debt-to-income ratios.
Parent PLUS loans also give parent borrowers a range of extended and graduated repayment options, from 10 to 30 years. Parent PLUS loans are eligible for deferments and forbearances to protect against financial hardship or unemployment. Parents might qualify for public service loan forgiveness if they’re a government or nonprofit employee.
There are also no aggregate limits on the amount you can borrow with a Federal Parent PLUS loan, and annual limits are up to the full cost of attendance. This might seem like a big advantage, but it can also cause some parents to borrow more debt than they can afford, risking delinquency and default. And because Parent PLUS loans can’t be directly transferred to one’s children, they won’t be allowed to take over the debt in the future.
Private Parent Loans
Like a Federal Parent PLUS loan, private parent loans are in the parent’s name only, not the student’s. But there are some differences between borrowing from a private lender and the U.S. Department of Education.
On the interest rate front, your private parent loan APR may actually end up being lower than a Federal Parent PLUS loan, if you have excellent credit. But, be careful when comparing the fixed interest rate on a federal loan with the variable interest rate on a private loan. The variable interest rate has nowhere to go but up, and may ultimately cost much more than the fixed rate on the Federal Parent PLUS loan.
Most private parent loans also have no fees of any kind, unlike Federal Parent PLUS loans. Depending on the repayment term, 4% in loan fees can be the equivalent of as much as a one percentage point higher interest rate.
Remember that private lenders set their own terms, rules and regulations, so private parent loans are less likely to offer some of the flexible options you’d get with a federal loan. For example, most private loans do not offer income-driven repayment or loan forgiveness.
When considering a private loan, be sure to shop around, because the loan terms will vary by lender.
Private Student Loans
Undergraduate and graduate students may seek out a private student loan if they’ve reached their federal student loan limits and they need more money to cover their college costs.
Private student loans have higher loan limits than federal student loans.
Private student loans do not require the student to file the FAFSA.
Private student loans require the borrower (and cosigner) to have very good credit scores and to satisfy other credit criteria. Not only does this affect eligibility for a private student loan, but it can also affect the cost of the loan. If your credit is any less than excellent — not uncommon for students just starting on their financial journey — you may have to settle for a high interest rate.
Most college students cannot qualify for a private student loan on their own, without a cosigner. More than 90% of private student loans to undergraduate students and more than 75% of private student loans to graduate students require a creditworthy cosigner.
In most cases, the cosigner will be the student’s parent. So, parents are still on the hook even if the student borrows a private student loan.
While many lenders offer cosigner release options, few borrowers will qualify for cosigner release. Refinancing the private student loans without a cosigner is another option, but again, few borrowers will qualify. If a borrower qualifies for a refinance without a cosigner, they might have to agree to a loan with a higher interest rate, unless the borrower’s credit score beats the cosigner’s original credit score.
Interest rates on private student loans tend to be higher than for federal student loans. Private lenders may offer borrowers some additional perks, like interest rate discounts if they sign up for automatic payments.
Details of private student loan terms may vary from lender to lender. Some lenders offer fixed interest rates, some do not. Variable interest rates will fluctuate as frequently as monthly. Some lenders offer death and disability charges similar to those on federal student loans, but many do not. Other advantages inherent to federal student loans may be unavailable, such as income-based repayment plans, longer deferment and forbearance periods, and loan forgiveness.
Examine Your Options
Student loans can be a huge financial commitment, even if you are just cosigning a private student loan, so review your choices carefully before making a decision.
What are your priorities? If a low, fixed interest rate is important to you, plus availability of income-based repayment, deferment or forbearance, and public service loan forgiveness, then a Federal Parent PLUS loan may be for you.
If your credit is exemplary and guarantees you a lower interest rate, a private parent loan may be the right choice.
Or maybe cosigning a son or daughter’s private student loan is the most practical option, since both parent and student can share responsibility for the debt. It can be an opportunity for the family to learn the need for responsible credit management.
By doing your research and comparing the tradeoffs side by side, your can find an affordable loan that’s right for your finances and your student’s education.