The Perils Of Parent PLUS Loans

When evaluating college borrowing options, federal PLUS loans are a favorite option for parents — yet there are systemic issues surrounding these loans that might not be well understood by many. Here are four main issues important for both advisors and prospective borrowers to be aware of when determining whether a federal PLUS loan is the best financing option for their situation.

Financial Aid Award Letter Confusion

Current or prospective students and parents who fill out the Federal Application for Student Aid, known as the FAFSA, become eligible for a parent PLUS loan. Subsequently, a financial aid award letter details what aid the student is eligible to receive. However, these letters lack uniformity in presenting the difference between gift aid, which does not need to be repaid (e.g., grants, scholarships), and self-help aid, which does need to be repaid (e.g. federal Stafford loans for undergraduate students). Some schools have omitted the word “loan” from PLUS award letters, which can mislead families into believing the assistance need not be repaid. To avoid confusion, families should carefully review award letters with their advisor to determine the appropriate aid.

Lack Of Cost Transparency

The interest rate for PLUS loans disbursed between July 1, 2021, and June 3, 2022, is 6.28% (calculated by adding 4.6% to the most recent 10-year Treasury note auction, which was May 2021). These loans carry fixed interest rates, yet they change each year a parent borrows — an important consideration relative to the borrowing timeline. By May 1, students typically have decided which school they will attend, and families have likely determined how much they need to borrow to meet the funding gap — all before federal loan interest rates are determined for the upcoming academic year!

Beyond this, origination fees imposed on the loans are the main transparency concern. For PLUS loans disbursed between Oct. 1, 2021, and Sept. 30, 2022, an origination fee of 4.228% is imposed — extremely high, considering most private education loans impose no such fees, and the average origination fee on a mortgage is around 1%. These fees increase the cost of the PLUS loan while making it more difficult to compare against a private alternative.

Private lenders are required to display APR figures whereas the U.S. Department of Education is not. This means a private loan, sporting a higher stated interest rate, could be more cost effective than a PLUS loan carrying a lower stated interest rate. Families evaluating federal and private financing options should consider working with an advisor to run simulations with varying repayment terms to determine APRs for the PLUS loan, allowing for a true “apples to apples” comparison.

Too Easy To Borrow Too Much

A parent’s eligibility to borrow PLUS loans simply requires not having an adverse credit history. What’s not directly considered is a borrower’s credit score, assessment of income, or other traditional measures used to determine creditworthiness or ability to repay. Further, there are no annual or cumulative borrowing limits imposed on PLUS loans (instead, limits are tied to each school’s cost of attendance less the amount of a student’s financial assistance). Therefore, it’s possible for less-qualified borrowers to access other types of debt and borrow at levels greater than they can reasonably expect to repay.

Advisors working with less-affluent families should perform an assessment of their ability to repay this debt instead of defaulting to borrowing the maximum amount to fill the gap. Advisors should encourage more affluent families to consider private loans, especially for borrowers with strong credit profiles who intend to repay the debt over a shorter period post-graduation.

Limited Repayment Options

For some parent borrowers, PLUS loans are the best option due to the current interest rate environment, ease of borrowing and flexibility with the amount. Still, parents should be aware of the repayment plans that are — and are not — available to them.

Most student loan borrowers opt for the standard 10-year repayment plan, but growing in popularity are income-driven repayment plans such as IBR, PAYE, and REPAYE. Conversely, the only income-driven repayment plan available for parent PLUS loan borrowers is an Income-Contingent Repayment (ICR). This is not as favorable as the IDR plans available to student borrowers because ICRs boast higher monthly payments and longer repayment terms.

Additionally, a parent borrower can only enroll in an ICR if their PLUS loan(s) has/have been consolidated with others into a direct consolidation loan. While it’s possible for parent borrowers to participate in other IDR plans through the double consolidation strategy, it becomes more complicated and is not a viable strategy for borrowers with a single PLUS loan, or those who have already consolidated loans into a direct consolidation loan.

At the end of the day, PLUS loans can be a great financing option for some borrowers and sub-optimal for others. Millions of parents favor these loans, and advisors should be cognizant of the associated planning opportunities — and pitfalls — so they can help borrowers achieve their higher education goals in the most financially efficient manner.

Ross Riskin is an associate professor of taxation and the director of the CFP and ChFC Education Programs at The American College of Financial Services. He may be contacted at [email protected].