When Carol Coleman went to college, she didn’t need scholarships or financial aid to pay for her expenses. Her father gave her $800 a semester, and it was enough to cover all of her costs. Now, as a 51-year-old flight attendant and single parent, she’s shouldering $70,000 in Parent PLUS loan debt she borrowed to pay for her daughter’s degree at Michigan State University.
“I never imagined I would have such huge debt,” Coleman says. “I saved, and I’m frugal. How did this happen to me?”
For some families, borrowing money is the only way they can afford a higher education for their child. But taking on a parent loan or co-signing a loan with your child is expensive. It also could jeopardize your credit or ability to borrow — or even lead to default.
Here are three common risks that parent borrowers face and how to avoid them.
1. Overborrowing Parent PLUS loans
Unlike with undergraduate federal direct loans, you can pay up to the total cost of attendance annually after other financial assistance with Parent PLUS loans.
The annual and overall limits on federal direct subsidized and unsubsidized loans can keep students from taking on too much student debt. But the lack of a similar limit for PLUS loans can lead to overborrowing by parents. Coleman’s daughter, for example, has loans of her own, but Coleman’s debt is greater.
Among those who borrow to pay for college, parents borrow an average $3,915 more in loans than students, according to How America Pays for College 2016, a study by Sallie Mae and market research firm Ipsos. In the 2015-16 academic year, parents borrowed an average $11,293 in PLUS loans, while students borrowed an average $7,378 in federal student loans.
Taking on loans is especially costly for parents because interest rates on Parent PLUS loans are significantly higher than those of federal direct subsidized and unsubsidized loans available to undergrads: 7% compared with 4.45% for the 2017-18 academic year. A subsidized loan means the government pays the interest while you’re in school.
Coleman says that by the time she starts paying off the PLUS loan, she’s not sure what her monthly payment will be. But if it’s greater than $300, she doubts she’ll be able to meet it every month.
Parent PLUS loan borrowers also have fewer repayment options compared with federal direct subsidized and unsubsidized loan borrowers. Coleman says she plans to consolidate her loans to qualify for income-contingent repayment – the only income-driven plan for PLUS borrowers.
To reduce risk: Make sure your child completes the Free Application for Federal Student Aid, or FAFSA, and maxes out subsidized and unsubsidized federal loans before you borrow money yourself.
2. Co-signing a private loan before maxing out federal loans
Turn to private loans only after your family has exhausted grants, scholarships, out-of-pocket savings, work-study and federal student loans. Private loans tend to carry higher interest rates than federal loans and don’t offer the federal protections, loan forgiveness and flexible repayment options that federal student loans do.
If there’s a gap to close, your child may need a private loan. And if your child is under 21, he or she will likely need a co-signer. You’ll be legally responsible for the debt if your child can’t pay. Co-signing a loan will also impact your credit history, and it may make it more challenging for you to take on other loans or lines of credit. The only way to get your name off a loan would be when the debt is paid or if your lender offers co-signer release after a period of time or through refinancing.
To reduce risk: Exhaust all other financial resources before borrowing a private loan. If you co-sign a loan, discuss the seriousness of the debt with your child.
3. Choosing variable over fixed-rate loans
The Federal Reserve has issued two hikes in the federal funds rate in 2017 and one more is coming. Borrowers who have variable interest rates on their student loans feel the increases, even though they’ve been only a quarter of a percentage point. The Fed says increases are expected through 2019.
To reduce risk: Stick with loans that have fixed interest rates so you can lock in lower rates before another increase. If you have federal loans with a variable interest rate, which were last issued in 2006, you can consolidate federal loans through a federal direct consolidation loan to lock in a fixed rate. If you have a private loan with a variable rate, you could refinance through a lender to get a fixed rate loan. If you don’t opt to consolidate federal loans or refinance private ones, then make a plan to pay off your loans quickly.