If you thought Gucci and Prada were expensive, try getting a college degree.
According to the Education Data Initiative, the average U.S. student pays $35,720 a year for their college education.
While most students are eligible for some form of aid, income and savings still play an important role in covering the majority of academic costs.
However, not every parent is in a position to help their kids financially. That’s when applying for a federal Direct PLUS loan may come in handy.
What is a Parent PLUS loan?
You’ve probably heard about Direct Subsidized and Direct Unsubsidized federal loans, or at least have seen them listed as part of your financial aid package on your school’s award letter.
But there’s a third type of federal loan that’s usually not included in there, and that you can also take advantage of, as long as your parents are okay with it.
That loan, my friends, is called the Direct PLUS loan.
In case you’re wondering, the “PLUS” stands for Parent Loan for Undergraduate Students, but that acronym is kind of obsolete, as these loans have been available to graduate students since July 1st, 2006.
Parent PLUS loans are a type of unsubsidized Federal Direct loan that your parents can take out on your behalf to pay for both your tuition and living expenses. These loans are typically used when other forms of aid, including scholarships, grants, and other types of federal loans aren’t enough to cover all the costs of attendance.
Unlike other types of federal loans, the federal PLUS loan does require a credit check for approval, as these loans have a higher borrowing limit.
They have a fixed interest rate, which is currently set at 6.28%, and can be repaid over a maximum of 30 years.
Who is eligible for a Parent PLUS loan?
According to the office of Federal Student Aid, Parent PLUS loans can be taken out on your behalf by either one of these people:
- Your biological parents.
- Your adoptive parents.
- Your stepparents.
Grandparents and legal guardians can’t apply for a PLUS loan – even if they raised you and support you financially – that is, unless they adopt you.
To be approved for a PLUS loan…
- The parent borrower can’t have an adverse credit history (aka a poor loan or credit card repayment history).
- Both you and your parents must demonstrate financial need.
- You must be a dependent undergraduate student, who’s enrolled in school at least part-time.
It’s worth noting that even if your parents do have an adverse credit history, they may still qualify for a PLUS loan if they’re able to prove that the late payments were caused by extenuating circumstances.
They also have the option to have someone “endorse” or co-sign on the loan. The endorser can’t have an adverse credit history and will be legally responsible for repaying the loan if your parents default.
What if my parents can’t prove extenuating circumstances or don’t have a co-signer?
I’m glad you asked.
If that’s the case, they should apply anyway, as getting denied for a PLUS loan has its benefits.
It turns out that if your parents get denied for a PLUS loan, the Department of Education will raise your annual federal loan limit to match that of independent students. That means that you could get between $4,000 and $5,000 more each year in federal loans, depending on the academic year.
How much can you borrow?
One of the perks of PLUS loans is that they allow your parents to borrow an amount equal to your school’s certified cost of attendance, minus other financial aid received – including other federal loans.
Let’s say your cost of attendance for this academic year is $30,000 and you got $4,000 worth of scholarships and grants. You’re a college freshman, so you also got $5,500 in Direct federal loans.
That means you got a total of $9,500 in financial aid, so your parents can borrow up to $20,500 in PLUS loans.
Be careful not to borrow too much
Just because your parents are entitled to a certain amount, that doesn’t mean that they should borrow it. Amy Lynn Richardson, CFP with Schwab Intelligent Portfolios Premium, says that it’s is still very “important to set realistic expectations about your ability to repay these loans in the future.”
In other words, it’s best to not bite off more than you can chew.
Before you take out the loan, Richardson recommends that you sit down with your parents and research what the starting salary range is for the career path you are choosing, along with early-career earnings.
You can run these numbers with the help of a salary-reporting website like PayScale, which offers this information for free.
How to apply
Each school has its own application process, but most of them will ask your parents to apply online on StudentAid.gov.
Here’s a checklist of what they’ll be asked to provide during the application process:
- A verified FSA ID. This is a unique number that’s given to them when they create an account on StudentAid.gov. This number is also used to complete the FAFSA.
- Your school’s name. So they can confirm the cost of attendance, which will determine your borrowing limit.
- Your personal information. Full name, permanent address, social security number, date of birth, and telephone.
- Their (your parents’) personal information. Permanent address, email, and telephone.
- Their (your parents’) employer’s information. Name of the company, telephone number, and address.
The application takes about 20 minutes to fill out, and it must be completed in a single session.
How disbursement for PLUS loans works
Once the loan is approved, the funds are sent directly to your school, so they can apply it to your tuition and fees.
What happens if there’s any money left after that?
There are two options: the loan funds are either sent to your parents, or to you, depending on whether your parents authorized you to receive the remaining amount during the application process.
What to consider before applying for a Parent PLUS loan
Megan Walter, a policy analyst at the National Association of Student Financial Aid Administrators (NASFAA) says that PLUS loans can be a good alternative to taking out private loans, primarily because of all of the protections that PLUS loan borrowers receive.
Some of these include being able to put the loans in deferment or forbearance if they’re in financial trouble, and being eligible for Public Service Loan Forgiveness if they work for a qualifying employer.
However, they also come with some drawbacks that are worth considering.
There’s an origination fee
An origination fee is a percentage that the lender charges from your total loan amount to process your loan.
All federal Direct loans charge an origination fee. However, PLUS loans have an origination fee of 4.2%, which is four times more than what you’re charged for Direct Subsidized and Direct Unsubsidized federal loans.
Walter says that means that if you filled out an application to borrow a $10,000 PLUS loan, you’ll only receive $9,577.20 of that amount.
If you happen to need the whole $10,000, that means you’ll need to borrow more than originally intended to cover the loan fee, without coming up short.
Your parents could pay more in interest
Although PLUS loans do require your parents to pass a credit check in order to be approved for the loan, the interest rate is the same for everyone, regardless of how good their credit is. This is because interest rates for federal loans are set by Congress.
So, if your parents have excellent credit, it wouldn’t hurt to compare rates from a private lender or two, to ensure they’re getting the best deal possible.
Repayment starts while you’re still in school
Unlike private student loans and Direct Subsidized and Unsubsidized federal loans, which automatically put your payments in deferment until six months after you graduate, repayment for parent PLUS borrowers starts as soon as the loan funds are disbursed.
Your parents can request for payments to be deferred until six months after you graduate, or drop below half-time enrollment, but they have to do so during the loan application process.
However, since Direct PLUS loans are a type of unsubsidized loan, interest will continue to accrue or accumulate during this time, and eventually will become part of the principal balance, making your debt more expensive.
They aren’t eligible for most income-driven repayment plans
One of the perks of using federal loans instead of private ones is getting access to income-driven repayment plans, which allow you to lower your monthly payment by taking into account how much you earn.
There are currently four types of income-driven repayment plans, however, Parent PLUS loans are only eligible for one of them, which is the Income-Contingent Repayment Plan (ICR Plan). This plan adjusts your monthly payments to 20% of your discretionary income.
Your parents’ finances and retirement age may take a hit
The debt-to-income ratio (DTI) is a percentage that measures how much of your monthly gross income is compromised by your monthly debt payments.
If payments are on the higher side, your parents’ DTI will jump, making it harder for them to qualify for things like a mortgage or to refinance a loan.
Richardson, from Charles Schwab, also notes that taking out such a loan could delay your parents’ retirement age, as they’d need to continue earning the same amount or more, to keep making payments, and ensure their own financial security.
PLUS loans can’t be transferred to you
“PLUS loans stay in the parent’s name for the duration of the loan’s life,” Walter, from NASFAA, says.
So, even if you’re the one making payments after you graduate, they’d continue to affect your parents’ credit and finances for the entire duration of the loan term, unless you refinance them with a private lender.
But refinancing a federal PLUS loan also comes with its drawbacks, as both you and your parents will lose benefits, such as being eligible for forgiveness and qualifying for the ICR plan that allows you to lower your monthly payment.
Parent PLUS loans can be a good alternative to student loans when other forms of aid fall short. However, applying for these types of loans isn’t something that should be taken lightly, as it is a decision that will affect your entire family, financially speaking.
That’s why it’s so important that you exhaust every and any form of aid, including other types of federal loans, before you and your parents take the plunge.
Featured image: Flamingo Images/Shutterstock.com
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