Parents should know the pros and cons of federal and private loans before borrowing to help their child attend college.
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Student Loan Ranger, currently authored by American Student Assistance®, helps prospective and current students and recent graduates make sense of borrowing options, student debt and loan repayment. The national nonprofit also runs Salt®, a free educational resource that provides personalized tools to help higher education consumers borrow and repay their loans in a way that works for them. The organization’s e-book, “100+ Ways to Get Rid of Student Loans (Without Paying Them),” offers guidance on the options that may forgive, discharge or pay for all or a portion of a borrower’s student loans.
During the summer months, college-bound students and their parents will pay their first tuition bill for the fall semester. Seeing the amount due can be a harsh dose of reality, especially since they may have to multiply it by four years and the number of children in the family.
Even after financial aid, families often face a tuition gap. To cover it, many parents take on debt.
According to Sallie Mae’s annual “How America Pays for College” report, in families that borrow to pay for college, parents take out loans 35 percent of the time. As a result, federal parent PLUS loan debt equals more than $75 billion – and that doesn’t account for private loans that parents borrow.
[Parents think hard before borrowing for or with their student.]
Taking on long-term debt can have a big impact on parents’ other financial goals, especially as they near retirement. Before you borrow for your student, understand what you’re getting into with these different funding options.
• Parent PLUS loans: Sometimes, schools include parent PLUS loans on award letters to cover tuition gaps. That doesn’t mean you have to use this funding option or that you will even qualify for it, since you’ll need good credit. However, if you do qualify, these federal loans generally present the safest option for borrowers.
As federal education loans, parent PLUS loans come with better repayment options than other private loan options. These benefits include more generous repayment, postponement and forgiveness options than most private loans. In addition, PLUS borrowers can consolidate these loans to take advantage of income-contingent repayment.
ICR bases your monthly payments on your income and family size, capping these amounts at 20 percent of your disposable income. After 25 years – 10 if you work for a public service or nonprofit employer – the remaining balance is forgiven.
That amount is taxable under the income-contingent repayment plan unless you obtain forgiveness under Public Service Loan Forgiveness first. Still, having lower payments could benefit you greatly if repayment stretches into your golden years.
[Discover four things borrowers don’t always know about parent PLUS loans.]
• Private student loans: It’s almost always better to borrow federal loans before private loans, largely due to the previously mentioned benefits. But to cover a tuition gap, parents may also borrow a private student loan or co-sign a private student loan with their child or another borrower with good credit. And while co-signing may seem like less of a commitment, it really isn’t.
As a co-signer, you bear equal responsibility for a student loan. Your child may agree to make all the payments, but if he or she doesn’t, you will be on the hook for that money – and your credit score and overall financial situation will suffer due to the delinquency or default. Another credit issue to note is that co-signing a private student loan and borrowing a federal parent PLUS loan will affect your debt-to-income ratio the exact same way.
The biggest benefit to private student loans is typically lower costs. Their advertised interest rates can be much lower than PLUS loans’ rates. However, you may not actually qualify for those low rates – they’re typically reserved for borrowers with excellent credit, and you may be unable to lock them in.
PLUS loans use a fixed interest rate. Currently, this is 7 percent. With a fixed rate, you’ll know exactly what you’ll owe each month and how that may fit within a fixed income during retirement.