Some student loans are borrowed by the student, some by the student with a parent as cosigner, and some by the parent on their own. Should the student borrow to pay for college, or should the parent borrow instead?
If a parent borrows to pay for their child’s college education, should they cosign a private student loan or take out a parent loan?
The term student loan is often used to refer to both types of education debt, including loans borrowed by the student and loans borrowed by the student’s parent.
Pros and Cons of Having the Student Borrow
Cost: Federal student loans are the least expensive, with fixed interest rates that are lower than the interest rates on any private or parent loan, even if the borrower has excellent credit. The interest rate is the same for all borrowers, even if they have bad credit.
Some federal student loans are subsidized, but parent and private loans are not subsidized. The federal government pays the interest on subsidized loans during the in-school and grace periods, as well as other periods of authorized deferment.
Wide Eligibility for Federal Loans: Eligibility for federal student loans does not depend on the student’s credit history in any way.
Better Payment Suspension Options: Federal loans provide more deferment and forbearance options than private loans. Federal loans offer an economic hardship deferment and unemployment deferment in addition to forbearances. Private student loans offer just forbearances. The deferments and forbearances for federal loans are also available for up to three years each, while forbearances for private loans are limited to a year in total duration.
The main problem with federal student loans is the low loan limits. When the student reaches these loan limits, further borrowing will involve private student loans, federal parent loans or private parent loans. (Needing to borrow private or parent loans may be a sign that you’re borrowing too much money and should perhaps enroll at a lower-cost college.)
Private student loans are much less available than federal student loans.
Limited Eligibility for Private Loans: Most students have a thin or nonexistent credit history and cannot qualify for a private student loan on their own. More than 90% of private student loans to undergraduate students require a creditworthy cosigner, which is usually the parent.
Pros and Cons of Cosigning Student Loans
Increased Approval and Lower Interest Rate: Cosigning a private student loan will not only help the student qualify for the loan, but it will also help them qualify for a lower interest rate. Parents may wish to cosign for their child’s private student loan even if the child could qualify for the private student loan on their own.
Negative Impact on Credit: A cosigned private student loan will affect the borrower’s and cosigner’s credit scores, because the cosigner is equally responsible for repaying the debt. A late payment or default will ruin the cosigner’s credit, not just the borrower’s credit. The cosigned loan will count as part of the cosigner’s debt-to-income ratio, making it more difficult for them to qualify for new credit, such as refinancing their mortgage.
Cosigner Release is Difficult: Some private student loans offer a cosigner release option, but it can be difficult for borrowers to qualify for cosigner release.
Not only must the borrower make 12, 24, 36 or 48 consecutive, on-time monthly payments, but the borrower must be able to qualify for the loan on their own, without a cosigner. Less than 10% of borrowers who apply for cosigner release will qualify.
Pros and Cons of Having the Parents Borrow
Higher Limits: The Federal Parent PLUS loan is available to parents of undergraduate students. The annual loan limit is up to the full cost of attendance, minus other aid received. There is no aggregate loan limit.
See also: Complete Guide to Parent Loans
Harder Eligibility: Unlike federal student loans, eligibility for a Federal Parent PLUS loan does depend on the borrower’s credit. The borrower of a Federal Parent PLUS loan must not have an adverse credit history, which involves a two-year lookback for serious delinquencies and a five-year lookback for bankruptcy discharge, foreclosure, repossessions, tax liens and wage garnishments.
The credit criteria for Federal Parent PLUS loans involve a more modest credit check than is required for private parent loans and private student loans. Private loans base eligibility on credit scores, minimum income thresholds, debt-to-income ratios and duration of employment.
Thus, parents can be approved for a Federal Parent PLUS loan even if their credit isn’t perfect. A few late payments aren’t going to stop a parent from qualifying, unless the payments are 90 or more days late. Bringing the late payments current can then let the parent qualify for the loan.
If the parent has an adverse credit history, they can qualify for the loan by getting an endorser who does not have an adverse credit history. An endorser is like a cosigner, but much less common. The student cannot be the endorser, however. Parents can also appeal an adverse credit history based on extenuating circumstances.
The student is not obligated to repay a Federal Parent PLUS loan, since their name is not on the loan. Parents cannot transfer the Federal Parent PLUS loan to the child, not even after graduation. The loan will remain on the parent’s credit report until it is paid off in full or refinanced into a private loan. Keep in mind refinancing federal loans into private loans means a loss in any federal loan benefits, including student loan forgiveness.
Limited Availability: Federal Parent PLUS loans cannot be borrowed by someone other than the parent, such as an aunt or uncle. A stepparent can borrow a Federal Parent PLUS loan, but only when they are married to the student’s biological or adoptive parent.
Higher Interest Rate: The interest rate on a Federal Parent PLUS loan is higher than the interest rate on federal student loans. The interest rates on Federal Parent PLUS loans are the same for all borrowers, without regard to the borrower’s credit scores. Borrowers of private student loans and private parent loans, however, may qualify for a lower interest rate than on a Federal Parent PLUS loan if they have excellent credit.
Current interest rates on a private refinance may also be lower than the interest rates on older federal loans, which may have been borrowed when interest rates were higher.
The Federal Parent PLUS loan charges a fee of about 4% of the loan amount. Most private student loans and private parent loans do not charge any fees. The Federal Parent PLUS loan fees are the equivalent of about a 1% higher interest rate over a 10-year repayment term.
Obligation to Pay: With a Federal Parent PLUS loan, cosigned private student loan and private parent loan, the parent is obligated to repay the debt. But, the student is not obligated to repay the debt on a Federal Parent PLUS loan or private parent loan. The student is responsible for repaying a federal student loan and a private student loan.
Impact on Retirement: Parents are closer to retirement than students, so parent loans may affect their retirement. Ideally, all debts should be paid off in full by the time the borrower retires because there is no new income in retirement. If the borrower is unable to pay off all debts by retirement, then they may need to reduce the monthly payment as much as possible by stretching out the repayment term.
This will minimize the impact of the loan payments on the borrower’s cash flow in retirement. All federal and many private loans have death discharges, so there is the possibility of having the debt outlive the borrower. Nevertheless, parent loans can have a significant impact on retirement.
Risks: Non-education loans, such as a home equity loan and home equity line of credit (HELOC) may offer lower interest rates, since they are secured loans, but they come with added risks. If you default on a home equity loan or HELOC, you can lose the home. If you default on a student loan, the lender cannot repossess your education.
See also: How Much Parent Loan Debt is Too Much
Tradeoffs between Student and Parent Loans
Rather than have the student borrow the full college costs, it may be best for students and parents to split the cost. When a parent borrows, it reduces the amount that the student must borrow.
But, beware of having the either the student or parent borrowing more than they can afford to repay in a reasonable amount of time.
Aim to have total student loan debt at graduation that is less than the student’s annual starting salary.
A similar rule of thumb applies to parents. Parents should borrow no more for all their children than their annual income. If so, they can afford to repay their parent loans in ten years or less. If retirement is less than ten years away, they should borrow less. For example, if the parents expect to retire in only five years, they should borrow half as much.
See also: Checklist for Reducing Student Loans
Comparison of Student and Parent Borrowing Options
This chart summarizes the important differences between student and parent borrowing options.
|Cosigner Required||None||Usually the Parent||Rare||None|
|Interest Rate||Fixed||Fixed or Variable||Fixed||Fixed or Variable|
|Loan Fees||About 1%||None||About 4%||None|
|Cost||Lowest||Highest, except if excellent credit||Higher||Highest, except if excellent credit|
|In-School Payment Options||Full Deferment||Full Deferment, Fixed ($25/loan) Payments, Interest-Only Payments, Full Payments||Full Deferment, Immediate Repayment||Full Deferment, Fixed ($25/loan) Payments, Interest-Only Payments, Full Payments|
|Repayment Plans||Standard, Graduated, Extended, Income-Driven (ICR, IBR, PAYE, REPAYE)||Level Payment||Standard, Graduated, Extended, Income-Driven (ICR if consolidated)||Level Payment|
|Can Change Repayment Plans||Yes||No||Yes||No|
|Death and Disability Discharges||Yes||Some||Yes||Some|