The Pluses and Minuses of PLUS Loans

Dear Carrie,

My daughter was just accepted to her dream university, but even with grants, scholarships, and 529 savings, I estimate she'll still need to borrow close to $80,000 if she graduates in four years. I'm considering taking out a PLUS loan to help cover the cost. What should I know?

Dear Reader,

First, congratulations on your daughter's acceptance to college and her financial aid package. Many higher-income parents forgo applying for financial aid because they assume their children won't qualify for grants or scholarships, but that's often not the case.

Still, as you're discovering, even a generous financial aid package won't always cover all the costs. In such cases, many parents borrow to help foot the bill, and a Parent Loan for Undergraduate Students (PLUS) is a common choice. Let's look at how PLUS loans work and what to consider before assuming such debt.

Direct PLUS Loans, also called Parent Plus Loans, are federal loans that let adoptive or biological parents of dependent undergraduate students take out loans to cover education expenses not covered by other types of financial aid. However, as with all forms of borrowing, there are benefits and drawbacks to PLUS loans. Here are the most important to consider.

• Easy to qualify: Unless you have what's deemed by the Department of Education as "adverse credit"—which includes bankruptcy, delinquent payment history, foreclosure, or repossession—you'll likely qualify for a PLUS loan.
• No borrowing limits: While the total amount an undergraduate student can borrow generally is capped at $31,000, a parent can take out a PLUS loan of up to the actual cost of attendance (as determined by the school)—which includes tuition and fees, room and board, books, supplies, and other expenses—less any financial aid the student receives. For example, if your daughter's annual cost of attendance is $40,000 and she receives $20,000 in financial aid, you can borrow up to $20,000 per year via a PLUS loan.
• Fixed interest rate: Interest rates for PLUS loans are fixed for the life of the loan, making it easy to factor payments into your budget.
• Tax-deductible interest: If your modified adjusted gross income is less than $85,000 ($175,000 for married couples), you can deduct all or a portion of your interest payments, up to an annual maximum of $2,500, from your taxable income. And because student loan interest is considered an above-the-line deduction, you can take it even if you don't itemize. (See "Is it deductible?" below.)
• Flexible repayment options: PLUS loans offer three repayment plans:
  • Standard repayment, in which you pay a fixed amount for up to 10 years.
  • Graduated repayment, in which your payments start out low and increase every two years, for up to 10 years.
  • Extended repayment, in which you pay either a fixed or graduated amount for up to 25 years. This option is available only for outstanding balances of $30,000 or more.

In all three cases, payments are due within 60 days of receiving the funds. However, you can opt to defer repayment while your child is enrolled at least half-time at an eligible school. Loan deferments expire six months after your child graduates, unenrolls, or falls below half-time status.

• High interest rates: The rate on PLUS loans generally is higher than you might find from other borrowing options. (The current rate, which resets annually on July 1, is 7.54%.) That said, you may be able to deduct some of the interest from your taxable income. (See "Is it deductible?" below.)
• Origination fee: On top of higher interest, you'll also pay an origination fee—currently 4.228%—that is subtracted from the loan funds prior to disbursement. For an $80,000 loan, the fee would be $3,382, meaning the total disbursed would be $76,618. You'll owe interest on and be required to repay the full loan amount, including the fee.
• No borrowing limits: Yes, this plus is also a minus. Unlike traditional lending options, which are limited by your ability to repay the loan, PLUS loans have no such requirements, making it easier to assume more debt than is prudent. Consider your own limits when deciding how much to borrow, perhaps with the help of your financial planner.

A look at who qualifies for tax-deductible student loan interest—and how to calculate a reduced deduction.

Modified adjusted gross income (MAGI):

• $70,000 or less (single or head of household) or $145,000 or less (married filing jointly): Full deduction
• More than $70,000 (single or head of household) but less than $85,000 or more than $145,000 but less than $175,000 (married filing jointly): Phased-out deduction (see below)
• $85,000 (single or head of household) or more or $175,000 or more (married filing jointly): No deduction

PLUS loans aren't your only options when it comes to borrowing for college. There are several other avenues you could pursue, including a home equity line of credit, personal loan, or securities-backed loan. Depending on your financial situation, these options could provide more attractive interest rates or more flexibility in terms of how you use the funds.

Unlike a PLUS loan, however, these options typically don't offer flexible repayment options, deferment, forbearance, or forgiveness, nor is the interest potentially tax-deductible.

As you consider your options, be sure to do so through the lens of your own finances—especially retirement. As the saying goes, you can borrow for school but not for retirement, so if paying part of your daughter's college bill will mean cutting back on your own savings, it's best to pursue other options.