On August 9, President Obama signed into law the Bipartisan Student Loan Certainty Act of 2013. This law changes how interest rates will be determined each year by using a market based rate approach instead of a fixed rate set by Congress. Much has been written of the various proposals that resulted in this compromise bill, but all agree that it results in lower student loan interest rates for students borrowing this year. Rather than face a Federal Direct Stafford loan rate of 6.8%, undergraduate students will receive a rate of 3.86% while graduate students will receive a rate of 5.41%. Less discussed, but also important is the change in the rate of Parent PLUS loans from 7.9% to 6.41%.
This presents families with an interesting decision as they contemplate whether to use Federal Student Loans or Private Student Loans to pay for their student’s education. In all cases, undergraduate students will receive a lower rate on a Federal Student Loan than they will on a Private Student Loan. Further, if a student is eligible for the Subsidized Stafford loan they will have the benefit of interest not accruing while they are in school.
Choosing Between Federal PLUS Loans and Private Student Loans
Where the decision between federal and private student loans gets interesting is when a family needs to borrow additional funds to cover the difference between their aid award (including Federal Student Loans) and the cost of attendance. The biggest challenge with a Federal Direct Stafford loan is that the maximum a student can borrow each year is $5500 as a freshman, $6500 as a sophomore and $7500 as a junior or senior. If the family needs to borrow more, the college will very likely refer them to a Federal Direct Parent Loan for Undergraduate Students or PLUS loan.
The PLUS loan program offers families the ability to borrow up to their student’s cost of attendance less other financial aid. The credit check for the program does not look at the parent’s credit score or if they can afford the payments, it only checks for items like timely payments and prior student loan defaults. As a result most families will be approved when they apply for the loan. The PLUS loan has an interest rate of 6.41% and an origination fee (deducted from proceeds) of 4.204%.
Interest Rate Differences Between PLUS Loans and Private Student Loans
When PLUS loans had a 7.9% rate, many families looked to fixed rate private loans as a lower cost solution. With the PLUS rate now reduced to 6.41% (or an APR of 7.33%) does it make sense for families to consider a private student loan over a federal student loan? The answer depends on the family’s credit. I did a survey of the major private loan lenders current offerings. Based on that research, families with strong credit should consider applying for a private loan rather than a PLUS loan. Why? Based on my research, the best fixed rate offerings on private loans today range from 4.50% to 6.49% with no origination fee (so the published rate is the APR). Again, the rate offering is based on the student and parent’s credit, so it’s possible the family may not qualify for these rates. But, if a family believes they have strong credit, it is worth investigation.
Is a Private Student Loan Riskier Than a PLUS Loan?
Families will often hear that there are more borrower protections for Federal Student Loans than there are for Private Student Loans. That is certainly true when looking at Stafford loans, but it is not as strong a case when comparing Private Student Loans and PLUS loans. For example, PLUS loans are neither eligible for Income Based Repayment programs, nor can they be consolidated with the student’s federal loans (parents may qualify for forbearance programs which should be considered). One of the largest benefits mentioned for PLUS loans though is that they are forgiven in the unfortunate case of the death of the student. In my research I found that most private student loans now offer that benefit as well. Families should confirm that feature is offered by their chosen lender before accepting a private loan.
Families with strong credit have multiple options to consider when financing their child’s education. It is in their interest to consider all options, federal and private, before they make the borrowing decision. In the case of PLUS loans, families should consider the impact to their monthly budget and savings. While they can defer payment until their student graduates, the loan payment will still be due and parents cannot expect the increased income potential that their student will after completing their degree. Private student loans are borrowed in the student’s name and co-signed by the parent. So long as the student can make the payments, the parents won’t have to face that increase to their monthly budget.
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