Beware the Euphoria Around College Acceptance Letters
Some schools try to describe a parental loan as ‘aid’
Any family weighing financial aid offers from colleges right about now needs to be on high alert that some schools are masters at obfuscation. They slide in federal loans that parents can take out to pay for college, called PLUS loans, as aid.
Recent analysis in the Journal of Financial Planning cites research of “award” letters from more than 500 colleges that found 15% of schools list PLUS loans as part of their aid package.
Grants and merit scholarships are defined as aid. Loans, on the other hand, are an expense borne by a college student’s household. And parents should beware the costs of borrowing from the federal PLUS program.
Federal loans: The good and the not-so-good
Federal student loans are a solid way for a family to borrow. The terms are fair, and there’s little chance an undergrad who finishes a degree with only federal student loans will have a hard time paying it back, given borrowing limits.
But federal loans to help parents pay for a child’s college costs, called PLUS loans, are more costly, and come at a life stage when many households should not be adding more debt.
PLUS loan problem #1: A high interest rate
The Department of Education sets the interest rate on PLUS loans once a year, and it is the rate charged on all borrowing between July 1 and June 30. (The academic year.)
Each May, the PLUS loan rate is set by starting with whatever the 10-year Treasury note rate is, and adding 4.6 percentage points to it. The 4.6 percentage points is called the margin. It’s a doozy. Undergrad student loans have a margin of 2.05 points.
In May 2020, at the depths of the pandemic, the 10-year Treasury note sunk to a record low of 0.70%, so the PLUS rate was 5.3% this academic year (4.6 + 0.7). It’s not likely going to stay that low for next academic year.
The 10-year rate has been climbing lately; at a March auction, it was 1.54%. If that holds until May, it suggests parent PLUS borrowers will face a 6.14% interest rate for loans taken out for the 2021-2022 academic year. The rate if their kid borrows for undergrad studies would be 3.59%.
PLUS loan problem #2: High origination fee
OK, we’re all used to paying lenders some sort of upfront cost when we borrow money. But the federal college loan program takes a mighty pound of flesh from parents. The origination fee for a PLUS loan is 4.228%. The origination fee when their kids borrow from the federal government is 1.057%.
PLUS loan problem #3: Crowding out other household must-dos
Total outstanding PLUS loan debt at the end of last year passed $100 billion for the first time, an increase of more than 40% in just five years. As Ross Riskin, CPA, points out in his Journal of Financial Planning article, that is likely a conservative estimate, as it does not include multiple PLUS loans that parents have consolidated into one loan for repayment.
According to an annual report from student loan servicer Sallie Mae and market research firm Ipsos, 13% of parents took out a PLUS loan in the 2019-2020 academic year, and the average amount borrowed was around $7,000.
Unlike undergrad student loans, repayment of PLUS loans starts immediately. That likely makes it hard for many households to simultaneously make PLUS loan payments and tackle other financial goals. Say, saving for retirement.
The $7,000 average PLUS loan amount just happens to be the annual maximum anyone at least age 50 could contribute to an individual retirement account (IRA) this year. But likely won’t if they are weighed down with student loan debt. Miss four years of saving, and you’re looking at foregone retirement savings of around $40,000 at age 65, assuming the money grows at an annualized 5%. And that’s just borrowing for one kid for four years.
PLUS loan problem #4: No one’s there to say you can’t afford it
It would be absurd to presume we could get a mortgage or car loan without having to prove we’re a pretty good bet to pay it back. Yet there is no check of parents’ debt-to-income level or credit score to suss out if they can handle PLUS debt. And no limit to what can be borrowed.
It doesn’t take a college education to know that can lead to overborrowing, no matter how well-intentioned.