Parents want what’s best for their kids. But more and more, they’re realizing that borrowing thousands to afford a child’s dream school might not be what’s best for them.
“People will lend you money to go to college, but they won’t lend you money to retire,” says Delia Fernandez, a certified financial planner and president of Fernandez Financial Advisory LLC in Los Alamitos, California.
From 1989-90 to 2011-12, the percentage of federal student loan borrowers with parent PLUS loans grew 385%, according to a new analysis by NerdWallet, from 4.1% of all borrowers to 19.9%. The average total amount paid on those loans, including interest, more than doubled in that time, from $15,323 to $40,154. Parents repay PLUS loans during crucial retirement-saving years. The sooner you lower your loan burden, the more money you could earn from compound interest accrued through investments.
Here’s a look at how much PLUS loans are costing parents and some repayment strategies, such as refinancing and income-contingent repayment, that can save them money.
Parent PLUS loan borrowing is rising fast
Between 1989-90 and 2011-12, the average amount of parent PLUS loans borrowed per student more than tripled, from $8,900 to $27,700. According to NerdWallet’s analysis, the average total interest paid rose from $6,423 to $12,454. That’s a nearly 94% increase in interest the average borrower owes on parent PLUS loans.
PLUS loan borrowing can get out of hand faster than undergraduate borrowing. That’s because you can take out PLUS loans for the total cost of attendance at your child’s school each year. The average price for an on-campus student to attend a four-year school was $30,320 a year in 2013-14, the latest year for which data were available. Over four years, that’s $121,280, not accounting for tuition increases. By contrast, dependent undergraduates are limited to borrowing $5,500 in federal direct loans as freshmen and $31,000 total throughout their college years.
“For some people, it’s like having a mortgage. They can have over $100,000 in parent PLUS loans,” says Ginny Schroeder, leader of counseling services at FISC Consumer Credit Counseling of Northeast Wisconsin. “They feel that they have to do it because their child couldn’t go to school unless they did it, and that’s just not true.”
In fact, many financial advisors counsel their clients not to take out PLUS loans at all. Students can apply for private scholarships, cut costs by living at home for the first few years, and consider borrowing as much of their family’s loan obligation as possible in their own name.
How to reduce your parent PLUS loan debt
Many borrowers don’t recognize the downsides of PLUS loans until they come due. Nikki Lambert, 23, says her parents borrowed about $150,000 in PLUS loans to send her from her hometown of Columbus, Ohio, to the University of Tennessee.
“I’m the first in my family to go to college, so none of us knew what we were doing,” she says.
Their payments are nearly $1,700 a month, and the family postponed them while Lambert applied for full-time jobs. She recently got a job offer, and she plans to contribute to the monthly bill.
Beyond encouraging your child to help pay your PLUS loan bill, the following alternatives can help you save money to put toward retirement instead.
Option No. 1: Refinance your parent PLUS loans
Parents are often good candidates for student loan refinancing, in which a lender pays off your PLUS loans and issues you a private loan with a new interest rate. Generally, you’ll need good credit and income that’s higher than your loan balance to qualify.
The more attractive your financial profile to a lender, the lower an interest rate you’ll get. Since parent PLUS loans carry higher rates than other types of federal student loans, including subsidized and unsubsidized direct loans and Perkins loans, the savings from refinancing may be substantial.
Since refinancing turns federal loans private, you would have no opportunity for student loan forgiveness or paying off the loan through income-contingent repayment (which we’ll tackle later). But if you don’t plan to use those benefits, transferring the loan could be worth it.
How much you could save: If you refinance $50,000 in combined parent PLUS loans from a 7% interest rate to a 5% interest rate, you could save $1,535 over time and lower your monthly payment by more than $130.
On the standard 10-year repayment plan, you’d pay $19,665 in interest over 10 years and $69,665 overall, and your monthly payment would be $581.
Say that two years into repayment, you refinance your remaining $42,581 PLUS loan balance to a 10-year loan at a 5% interest rate. That means you’d take 12 years to pay off your loan instead of 10, but you’d save money in both the long and short term. You’d pay $68,130 total over the life of your PLUS loan, pre- and post-refinancing. That’s $1,535 saved compared with not refinancing. Plus, your monthly payment would drop from $581 to $450.
Here’s what your savings would look like if you contributed that $131 monthly savings to an investment fund with a 4% rate of return.
Option No. 2: Transfer your parent PLUS loans to your child through refinancing
The government doesn’t allow you to transfer your PLUS loans into your child’s name and keep them federal. But refinancing lenders including CommonBond, Darien Rowayton Bank and SoFi will let your child take over your PLUS loan and refinance it in his or her own name.
Your child must be able to qualify for refinancing on his or her own, and eligibility requirements vary from lender to lender. If your child refinances a parent PLUS loan along with his or her federal student loans, he or she will lose the student loan forgiveness and repayment benefits specific to federal loans.
“If they’re in a good career — a good professional career, especially — then that’s not as big of a risk,” Schroeder says.
If you transfer the loan to your child, you’ll no longer be responsible for repayment.
Option No. 3: Sign up for income-contingent repayment and Public Service Loan Forgiveness if you qualify
PLUS loans aren’t eligible for the federal government’s income-driven repayment plans, including the newest and most generous, Revised Pay As You Earn.
But you have another option: You can turn your PLUS loans into a federal direct consolidation loan and sign up for income-contingent repayment, which reduces your monthly payment. Consolidating your loans means you’ll have one monthly payment instead of several, and your new interest rate will be a weighted average of your previous rates, rounded up to the next one-eighth of 1%.
Under this program, your bill would be 20% of your income or the amount you’d pay on a fixed 12-year repayment schedule, whichever is less. Income-contingent repayment offers forgiveness after 25 years if you’re still making payments at that time.
If you can combine this plan with Public Service Loan Forgiveness, the government program that forgives nonprofit and government employees’ loans after 10 years of payments, you’d benefit even more. Nikki Lambert’s mom, for instance, works for the YWCA, a nonprofit organization, so she’ll qualify for forgiveness on her consolidated PLUS loans through Public Service Loan Forgiveness after she makes 120 on-time payments.
How much you could save: If you switch from 10-year standard repayment to income-contingent repayment on a $50,000 PLUS loan balance, your monthly payment could be reduced by more than $100.
Say you’re a parent who earns $75,000 a year and you don’t have any dependents at home. Monthly payments on a $50,000 parent PLUS loan with a 10-year repayment term and an interest rate of 7% would be $581. If, after two years, you consolidate the remaining $42,581 balance and sign up for income-contingent repayment, your new monthly payment would be $465 initially. It would go up or down as your income changes, but that’s $116 in monthly savings to start.
For borrowers with an even higher balance, like the Lamberts, who owed $150,000, the monthly savings would be even greater. Their combined income is $75,000 a year, Nikki says, and their monthly payment would drop from $1,742 to $985.
But remember that on income-contingent repayment, since you’d be paying less per month, you’d accrue hefty interest charges and your total balance would grow over that time. Also, according to current IRS rules, you’d be required to pay income tax on the amount forgiven.
Parents should use income-contingent repayment only if they don’t qualify for refinancing and they need a lower monthly payment indefinitely. It’s especially useful if they’re eligible for Public Service Loan Forgiveness; the amount that’s forgiven on that program won’t be taxed.
Put the amount you save every month toward retirement savings, either in an employer-sponsored 401(k) or an IRA. The sooner you lower your PLUS loan payments and save extra, the better, says Chris Chen, a wealth strategist at Insight Financial Strategists LLC, in Waltham, Massachusetts.
“The farther away you are from retirement, the more you can take advantage of the compounding effect of being invested over a longer period of time,” he says.
You might also want to pay off credit card debt or put money in a reserve savings account, if you haven’t already, so you can cover household or car repairs during your retirement years. Getting PLUS loans under control should be one more stop on the road to retirement. Let these strategies inspire you to take action now.
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