How to Survive Predatory Parent Plus Loans - DailyFinanceJuly 15, 2015
How to Survive Predatory Parent Plus Loans
Jul 16th 2015 10:36AM
Direct Plus loans, frequently called Parent Plus, are probably the most irresponsible form of government lending in the entire student loan market.
Even though the federal government knows the income and repayment capability of a parent, those facts are ignored when deciding how much money to lend. Instead, Parent Plus loans only consider how much the education costs, and how much money needs to be borrowed to fund that education. Credit requirements focus only on major derogatory items on your credit report. If you are seriously delinquent or had previous bankruptcy or foreclosure, you would be declined. But your ability to repay is ignored. Someone with an annual income of $20,000 could theoretically borrow $40,000, so long as they are current on all of their obligations.
When new hires start working for a bank, they are taught the basics of underwriting. A very basic lesson is that you should determine whether or not the borrower has the ability to repay that loan. Every time we ignore a borrower’s ability to repay, we end up in trouble. The 2008 mortgage crisis was probably one of the greatest examples of ignoring repayment ability. Unfortunately, the lowest income parents are most vulnerable to these loans. Because of the ever-increasing cost of education, parents are often asked to borrow additional money to fund their child’s education.
Here are some of the biggest problems with Parent Plus loans:
The responsibility of the loan remains with the parent and can never be transferred. Even in retirement, wages could be garnished and assets seized to collect the debt.
It is almost impossible to have these loans discharged in bankruptcy.
The interest rates have historically been much higher than federal loans granted to students.
Although loans to students aren’t repayable until after graduation, loans to parents become due as soon as they are disbursed.
If you need to take out a Parent Plus loan, you should consider your options carefully. I recommend that all parents answer these three questions:
Can I afford the monthly repayments on this loan?
Am I getting the cheapest interest rate?
Should I really borrow with a Parent Plus loan?
Can I Afford the Monthly Repayment?
Remember that the Department of Education won’t figure out whether or not you can afford the monthly payments. But you will need to figure out whether or not you can afford the loan.
You should start by creating a written budget. Take stock of how much earn and spend each month. There are some excellent tools to help you do this, including Mint and LevelMoney.
To see if you can afford the monthly payment on the loan, consider the 50/20/30 budgeting method, which is a useful guide. Specifically:
No more than 50 percent of your monthly take-home pay should be used for fixed expenses. That includes your mortgage or rent, car payments, insurance, gym memberships or any other fixed expenses.
20 percent of your income should go towards your financial goals. That includes saving for retirement and saving for your child’s college. It also includes goals like paying down your credit card debt. Your Parent Plus loan payment should fit into this 20 percent.
30 percent of your monthly income can be used for flexible spending. That includes groceries, restaurants, entertainment, travel and more.
Compare your historic spending, and see if you have been keeping within this budget. And consider your life if you took on the Parent Plus loan. Don’t fool yourself, because the Parent Plus loan can never go away. If you are already spending 70 percent on fixed expenses and your credit card debt, you won’t be able to afford more debt.
Cheapest Interest Rate
The federal government sets the interest rates on Parent Plus loans. However, there are now private lenders that can beat those rates. In order to qualify for a private loan, you would need to have a good credit score and strong income. You can find variable interest rates as low as 2.03 percent with some of the new lenders. You can compare the Parent Plus private loans at MagnifyMoney.
Should I Really Use a Parent Plus Loan?
If you take out a Parent Plus loan, it will be with you until it is paid off or you die. So, your goal should be to get the lowest interest rate possible. If you have equity in your home, using that may be a better option. Home-equity lines of credit are returning. Interest rates tend to be very low. The interest is tax deductible. And in many cases you can borrow over a longer term, reducing the monthly cost (although that will drive up the total amount borrowed).
Make sure you go into a Parent Plus loan with your eyes wide open. Only take out the loan if you can afford the monthly payments. Don’t think that your only option is the government. And consider other ways of borrowing, like home equity, before you make a final decision.
Nick Clements is a former banker, author and co-founder of MagnifyMoney.com. He used to run the largest credit card company in the United Kingdom, and now he is helping you save money.