19 Mar Are Direct PLUS Loans Better Than the Alternative? A Financial Aid Office Perspective
by Vikki Hampton, University of Connecticut
The student loan scandals from 2007/2008 left financial aid administrators scarred. Some of us are still afraid to talk about private student loans as an option for fear of the appearance that we have been inappropriately influenced by the lenders. This fear is understandable given the public beating financial aid offices took for their relationships with private student lenders. Led by former Attorney General Cuomo of New York, financial aid offices were painted with a broad brush and questions were raised about their integrity and mission to objectively do what is best for students and families. It was a difficult time for many of us in the field. However, should we now be asking ourselves whether the pendulum has swung and we are guilty of painting alternative lenders with the same broad brush? Are alternative loans really as bad as we think? Could they actually be a better option for some families?
Alternative loans (private student loans) have certainly become more attractive in the last few years. Prime and LIBOR rates have been as low as we have seen in many years. Many lenders who tightened their underwriting criteria in response to the credit crunch have since loosened those standards. Lenders are also coming out with more creative loan products that offer a choice of fixed or variable rates, interest only payments during school, and most now offer zero fees.
Direct PLUS loans have undergone some changes as well. They have a fixed interest rate of 7.9% and currently have a net fee of 2.5% after the up-front interest rebate. Due to the Budget Control Act of 2011, those fees will increase to 4% on Direct PLUS loans with a first disbursement date on or after July 1, 2012. The definition of adverse credit that results in a PLUS denial is also changing to include unpaid charge-offs and collection accounts. This will certainly result in more PLUS denials, though the impact may be minimal for our offices as many who have these derogatory items on their credit report were likely also 90 days delinquent on an account. The impact of this change remains to be seen.
That said, PLUS loans still have some attractive benefits that should be considered when determining which type of loan to borrow. As a federal loan, borrowers who meet the criteria are entitled to two years of Unemployment deferment, three years of Economic Hardship deferment, periods of forbearance, and discharge provisions for death of the borrower or student and disability of the borrower that are not available for private loans. (Note that some private lenders have recently begun to offer cancellation benefits if the student borrower dies). Most private student loans only offer up to one year of forbearance, however, compared to 5+ years of potential forbearance and 5+ years of potential deferment for federal loans. This could make a big difference in the ability to successfully repay a loan should economic hardship or lengthy periods of unemployment occur during repayment. Direct PLUS loans may also be deferred while the student is enrolled at least Half Time. Some private student loans allow this and others don’t. Families should be aware of that as well if they are unable to make regular payments while their child is in school.
Families should also consider the long term interest rate if they are considering a variable rate private loan instead of a PLUS or other fixed rate loan. Variable rate loans can look very enticing at first glance, but it is important to remember that Prime and LIBOR rates have been unusually low for the last few years. Instead of just comparing the current interest rate on a loan to the PLUS rate, we should consider the big picture. Most students take 10 to 20 years to repay their student loans. What might this interest rate look like in 10 to 20 years compared to the fixed 7.9 percent rate of a PLUS loan? To give you some idea, the average Prime rate over the last 20 years is 6.38 percent (compared to the current rate of 3.25%). The average 3-month LIBOR rate over the last 20 years is 3.66 percent (compared to the current rate of .50%). A private loan with a rate of Prime plus 2% is currently 5.25%, but would have averaged out to 8.38% over the last 20 years.
Perhaps the most important determining factor in whether a PLUS or a private student loan is the better choice for a family is the parent’s credit rating. The PLUS loan approval process does not look at a credit score or debt to income ratio. It simply looks for the absence of adverse credit (debt that is 90 days or more past due, bankruptcy, foreclosure, unpaid debt that was charged off). A parent with a high debt to income ratio or a less than stellar credit score may have trouble being approved (usually as co-signer) for a private student loan but would pass the PLUS credit check. Even parents who are approved for a private student loan may end up with a rate of Prime plus 2% or 3%, for example, and may end up paying less over time with a PLUS loan. Parents with excellent credit, however, may end up with a rate that, even given fluctuations in the Prime or LIBOR rate over time, may still pay less with a private student loan. Parents with excellent credit who also have resources to help them continue their payments in case of and economic hardship or period of unemployment may well be better served by a private student loan. Those with less than excellent credit may find that a PLUS loan offers a better rate that will still cost less over the repayment period, even when the 4% fees are taken out.
When we take the time to look at both loan products objectively, we find that there is no easy answer to the question regarding which loan is better. Many families are indeed best served by the Direct PLUS loan, but not all. To best serve the families who look to us for guidance, we need to put aside the notion that PLUS loans are always best and alternative loans are “bad” for students and instead take the time to educate them on the differences in loan types and their individual situation. Then we can get back to what we do best: helping our students finance their education.