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When it comes to paying for a child's college education, many families must weigh taking out student loans vs. parent loans. The decision will require taking into account several factors, including federal vs. private loans, the creditworthiness of the student and parents, whether the loans will qualify for government subsidies, and the plans to pay off the loan after graduation. This article will take you through important variables to help you make a better decision.
Federal direct student loans are those made by the federal government. They're taken out in the student's name, which means they're directly responsible for repaying the debt.
There are several enticing benefits to federal student loans:
That said, students are limited to the amount they can borrow each year.
You're considered an independent student if you're 24 or older, married, a graduate or professional student, a veteran or a member of the armed forces, an orphan or ward of the court, caring for dependents of your own, an emancipated minor, homeless, or at risk of being homeless. Students whose parents don't qualify for a Parent PLUS loan may qualify for the same level of unsubsidized loans available to independent students.
You may qualify for subsidized loans if you have financial need. Financial need is determined through the same form used to apply for financial aid, the Free Application for Federal Student Aid (FAFSA).
If you're eligible for a subsidized loan, the government will pay the interest due on the subsidized amount while repayment is deferred. So, while you're a student and not making payments, your loan won't accrue additional interest.
There are several different ways to repay federal student loans, giving borrowers a lot of flexibility on their monthly payments.
Fixed payment plans:
Income-based repayment plans:
Federal parent student loans are taken out in the parent's name on behalf of the student. They're also known as Direct PLUS loans.
Although parents will be able to borrow up to the full amount needed for their child’s education regardless of financial need, there are several drawbacks to federal parent student loans:
Although parents can ask for deferment or forbearance on the Direct PLUS loan, the requirements for the government to grant it are much higher than with student loans.
One workaround for the fixed payments and ineligibility for loan forgiveness is to use a Direct Consolidated loan. That requires rolling the Direct PLUS loan into a new, bigger loan -- possibly with a higher interest rate.
That loan would be eligible for income-contingent repayments and could be forgiven after 25 years of payments. Parents who qualify under the Public Service Loan Forgiveness program will be able to apply after 10 years of payments.
The federal government isn’t the only place to get a student loan. There are numerous private lenders, such as Sallie Mae, that are willing to help you pay for your child’s education.
Typically, private student loans are made in the name of the student. The parent may co-sign the loan, backing the payments for the student. In that case, the loan will show up on both the student’s and parent’s credit reports.
Private student loans are an option for students who need more money for school than they can receive from federal loans. Unlike federal loans, however, private loans usually require a credit check and demonstrable income.
Private loans will usually have a higher interest rate than federal loans, and there aren't any subsidies. Repayment plans may be stricter as well, and there's no loan forgiveness.
There may be opportunities to refinance the loan down the road if interest rates decline.
Less common are private parent student loans. These loans are given to the parents to pay for their child's education. They may be a good option for parents with very good credit since the interest rate could be lower than a Direct PLUS loan from the federal government.
Private (parent) student loans may not have an option for deferment or forbearance, so be sure to check with the lender on the terms. If you're unable to keep up with payments, it could be very damaging to your credit.
Deciding between a student loan vs. a parent loan will come down to several factors that are unique to each family.
It's important to discuss who will be responsible for paying, regardless of who takes out the loan. While parents may want to pay for their child's college, a student loan may still be a great option due to the lower interest rate and government subsidies. Ultimately, however, the student is on the hook for payments if the parent cannot come up with the money.
Likewise, a parent may take out a Direct PLUS loan with the expectation that the student will help pay for it after graduating. But the parent is still responsible in the eyes of the lender. So, be sure everyone's comfortable with the arrangements.
Combined with money in a savings account or investments in a 529 plan, a student loan can help bridge the gap to ensure your child gets the best education you can afford.