How do I know if I should select a PLUS loan or a private student loan?
That is a great question and one that we hear a lot from folks trying to figure out the best way to pay for college. Let’s take a deeper look at both kinds of loans so you can better decide what’s right for you.
Things to Consider When Deciding How to Pay for College
Before we begin our comparison, here are a few things to do when you’re preparing to pay for college:
- Look at your family’s financial situation to determine how much of your savings can go towards paying for a portion of your estimated college expenses.
- Then research and apply for free money such as scholarships and grants that you will not have to pay back.
- Choose a college that is right for you but one you believe you can reasonably afford.
- Complete the FAFSA and
- Utilize as much free money (federal work study, scholarships, grants, etc.) as possible, then as much cheap money (Federal Direct Student Loans) as needed before applying for private loans.
- Utilize your college’s payment plan program and pay as much as you can interest free each month.
If a gap remains in your financing, consider a Federal PLUS loan or private loan solution. Choosing one or the other is dependent on an individual family’s needs. For some, having a fixed rate on a loan is a priority because they like predictability. However, for others, the PLUS Loan charges too high a rate for that predictability – 7.9%. With additional fees, the PLUS loan may be too costly. Rates and fees are as of publish date – check out current rates and fees here.
A private loan option may be preferable for borrowers who qualify for a lower rate and will aggressively pay back the loan to mitigate the risk of future rate variability. If a private loan borrower decides to defer payments for as long as possible and interest rates were to increase later, it may increase the cost of repayment.
Let’s take a deeper look into both these option for filling the college funding gap.
What is a PLUS Loan?
A Federal Direct PLUS Loan (formerly the Parent Loan for Undergraduate Students or PLUS) is made by the federal government to help students cover the cost of college. There are two types of PLUS loans:
- for graduate or professional degree students and
- for parents of dependent undergraduate students.
For both, the federal government makes loans to eligible borrowers through schools participating in the Direct Loan Program and is a great option for many borrowers given that the criteria for being approved is based on credit alone.
For purposes of this post, we are going to focus on the PLUS Loan for parents. To qualify for a PLUS Loan, the borrower must be a parent (biological, adoptive, or in some cases, stepparent) of a dependent undergraduate student enrolled at least half-time at a school participating in the federal student aid program. The loan is in a parent’s name and remains in the parent’s name for the life of the loan. It cannot be transferred to a student.
Direct PLUS Loan Overview
- The lender is the federal government, through the U.S. Department of Education.
- Parent borrower cannot have an adverse credit history.
- There is a fixed interest rate of 7.9%
- The loan has a 4% loan origination fee, meaning a 4% fee will be proportionately deducted from each loan’s disbursed amount.
- Repayment on the loan begins once the loan is fully disbursed, or paid out, to the college
- The highest dollar amount a parent can borrow – is the student’s cost of attendance (determined by the college) minus any other financial aid received
- To receive a PLUS loan, you need to first complete the Free Application for Federal Student Aid and then apply directly on the federal government’s website.
Direct PLUS Loan – the pros
- There is no check on employment, minimum income, or debt-to-income ratios. You simply need to have fair to good credit and the absence of any derogatory credit in your history…making this loan much easier to qualify.
- Parents can borrow for their student’s education if they want the loan in their name only.
- Generally, lower interest rates than most private student loans.
- Loan fees will not exceed 4 percent.
- Standard repayment period of 10 years, which can be extended.
- Can delay payments for up to five years through forbearance; must request at origination of loan.
Direct PLUS Loan – the cons
- Available only for dependent undergraduate students enrolled at least half-time.
- Loan can only be used to pay current year’s cost of education.
- Repayment begins within 60 days of total disbursement.
- The loan is in the parents’ name and cannot be transferred to the student
- A 4% fee is charged.
What is a private student loan?
Now how about a private student loan?
A private student loan is made by a private (non-federal) lender – that lender can be national or local to your home town – a local credit union, community bank, and even some credit card companies. These loans are underwritten – which means they are based on your credit and other qualifying criteria. So if you do not have a full-time job and credit history, more than likely, you will need a cosigner. Let’s take a look at the typical qualifications so you can better identify your options.
- An adequate to good FICO score. This is a measurement provided by credit bureaus on your available credit, how well you managed that credit and a sample of your credit history (more info can be found www.annualcreditreport.com). In other words, do you have good experience in paying back credit cards and loans?
- Minimum monthly income. Lenders will also look to be sure there is a minimum amount of monthly income ranging between $1,500 and $2,500 to make sure you have the ability to make payments.
- Low debt-to-income ratio. Along these lines, some lenders may also want to review your debt-to-income ratio (add up all your monthly debt obligations from credit cards and loans and divide it by your monthly income). In most cases, this should be less than 45% and again shows your ability to pay back your loan.
- And lastly, lenders would like to know if your second toe is bigger than your big toe… Of course, I’m joking, but my point is lenders are thorough and this is why the vast majority of private loans require a cosigner. Even if you are the exception, take a look at adding a cosigner as it may help lower your interest rate significantly. Many times, this does NOT have to be a parent, either.
Private Student Loans – the pros
- Student takes out a loan in own name not the parents’ – making on-time payments and establishing credit history are important steps in building strong credit.
*Note: a creditworthy cosigner is usually required unless student has an established positive credit history.
- Students may be eligible for various programs including those with less than half-time enrollment, certificate programs, graduate and continuing education, K–12, health professions, law programs and more.
- Interest rates and/or fees are usually based on borrower’s and/or cosigner’s credit rating, which can result in excellent terms for borrowers with a very good credit history.
- Flexible repayment terms ranging up to 25 years, often based on loan balance, which usually results in lower monthly payments.
- Student may have the option to defer principal and interest payments until after graduation or dropping below half-time enrollment.
- Some private loans can be used for past-due balances.
*Note: the Student Choice solution may not be used for past-due balances.
Private Student Loans – the cons
- Interest rates and/or fees are usually based on borrower’s and/or cosigner’s credit rating, which can be limiting for borrowers without a good credit history.
- Interest rates may be higher than the PLUS Loan interest rate if the borrower doesn’t have good credit.
- Interest rates are usually based on a variable factor such as the Prime or LIBOR Index rate, and can change as often as each month, and some loans have no maximum.
*Note: Student Choice credit unions utilize a ceiling rate and limit the amount the interest rate may increase per period.
The Choice is Yours
The last thing you should do to make certain of your decision is to ask the financial aid office at the college or university being considered. I know that many of us out there hate to stop and ask for directions but this time, think of it as asking a friend if they like a pair of shoes or searching ESPN before making your fantasy lineup. It’s just good practice. The financial aid office is there to help you. Take advantage of their insight!
It is always best to have options when considering how to pay for college. Weigh the benefits of all options and find the one that best suits your family’s situation. Now that you have a better understanding of what these two loan products are, you can start the process. Remember the old saying, the early bird gets the worm and this holds true for college financing as well. Start the process early – you may find some free money that you never knew was there. And, even if you don’t, you will feel good having everything squared away. Good luck!