Having the “Right” Parent Sign the Application Could Mean Big Savings on Parent Plus Loans

Parent PLUS Loans have always been an expensive option for financing a child’s college education. They come with an interest rate that is higher that many private loans and an origination fee of over 4 percent for every new loan. But thanks to rules that went into effect more than 10 years ago, they also offer income-driven payment options and forgiveness plans that can free parents from unwieldy debt.

These rules, which went into effect on July 1, 2007, can make these loans a godsend for parents who will be near retirement when all of their children are out of college, when one parent earns much less than the other, or when one parent has a disability or chronic illness. Unfortunately, as many as 80 percent of parents know very little about these provisions. That’s a problem, because parents can only take advantage of them if the right parent signs the loan.

Who Should Sign?

The 2007 rules have made it possible for parents to consolidate their loans under the Direct Consolidation Loan Program. It’s under this program that parents can pay back their loan under an income-driven repayment plan called the Income Contingent Repayment plan, or ICR. In addition to lowering monthly payments, ICR provides for loan forgiveness after 25 years or, if one parent is working for a non-profit organization, in as few as 10 years.

 Here’s the catch: the provision applies to the parent who signed the loan. That’s why it’s important to understand the full scope of regulations about Parent PLUS Loans before signing on the dotted line.

Many parents assume that both of their incomes are taken into account for loan repayment, but that’s not the case with Parent PLUS Loans. ICR can be applied to one parent’s income—the one who signed for the loan. That’s why it’s to the parents’ advantage to have the parent with the lowest income or who will be working for a non-profit when it comes time to pay back the loan sign for it.

Figuring Out Payments

ICR payments are based on 20 percent of the parent’s income. While that might sound high, what makes this loan workable is that the 20 percent is calculated based on a parent’s discretionary income, which is lower than gross or even adjusted gross income. And remember, we are only talking about the parent who signed for the loan.

To calculate discretionary income, deduct the current poverty guideline (currently $16,960) for a family of two. from the parent’s adjusted gross income. Note that discretionary income also excludes the untaxed portion of social security and all other untaxed income.

So let’s look at how this can work. If the person who signed for the loan is only making $15,000 annually at a part-time job, receiving another $15,000 in untaxed social security and taking distributions of $70,000 from a ROTH IRA (for a total of $100,000), there would be zero payments required on the Parent Plus Loan until the time it is forgiven.

Who Can Take Out a Parent PLUS Loan?

Eligibility for a Parent PLUS Loan does not depend on the borrower’s credit scores or debt-to-income ratios. However, the borrower of a Parent PLUS Loan must not have an adverse credit history.

An adverse credit history may include:

a current delinquency of 90 or more days on more than $2,085 in total debt;

more than $2,085 in total debt in collections or charged off in the past two years (before the date of the credit report); or

default, bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment, or write-off of federal student loan debt in the past five years (before the date of the credit report).

If a parent has an adverse credit history, the parent can still borrow from the Parent PLUS Loan program if they submit a successful appeal for an exceptional circumstance, or if they use an endorser (cosigner) who does not have an adverse credit history.

Some Notes on Loan Discharge

Although income tax will be due on the amount forgiven under the 25-year repayment program, other discharge provisions are more attractive. There is no tax due when the loan is forgiven in 10 years for a parent working for a non-profit. In addition, if the parent who signed for the loan dies or is permanently disabled, the loan is discharged with no debt passed on to the parent’s spouse or other heirs.

What if the rules change? If the rules change prior to a parent’s first loan disbursement, they will be bound by the new rules. If the rules change after their first loan disbursement, they will be grandfathered into the rules in place at the time of their first disbursement.

More to Consider

The rules regarding Parent PLUS Loans are complicated, so parents should make sure they do their due diligence before they sign. And while the loans are a great option for some families, they are not for everyone. A family’s financial profile, where they have placed their retirement income and a parent’s age are among the factors families need to consider before taking out a loan. Finally, anyone who will require loans of $100,000 or more should only enter into the program with the help and guidance of a financial adviser or competent parent loan specialist.

Parent PLUS Loans can be a great option for some families, the key is to know the facts before you sign.

Matt Grzetich, of My College Planning Team in the Chicago area, received his BA in Organizational and Corporate Communications from Northern Illinois University.  He has over 10 years of experience in assisting families understand the enrollment and financial aid process within higher education.   He specializes in FAFSA, the appeals process, reviewing award letters and Title IV Funding options. Matt is passionate about helping families understand the financial aid process and navigate the most cost-efficient options to pay for college.

Email: mycollegeplanningteam@gmail.com