16 Mar Private Loans Versus PLUS Loans: Take Another Look

by Ben Brudnock, Vice-President, Citizens Bank

“Federal loans first.”

These three words have become a universal financial aid counseling staple since the elimination of the Federal Family Education Loan Program (FFELP) two years ago, and for good reason. Factors such as overall cost to the borrower, regulations on the aid office and disclosure requirements for lenders have served to stack the deck in favor of the Direct Loan PLUS program for both parents and graduate students.

But like all things in the world of student financial aid, nothing really lasts forever. As we look ahead to the 2012-13 academic year, financial aid officers will be challenged to review the offerings of private loans in comparison to Direct Loan PLUS and ask the question, “Will federal loans really be the better deal for all students and families?” In short, the answer is “no.”

When we take an objective look at both federal PLUS and private loans, one trend emerges: for those with solid credit, private loans are now more affordable.

It comes as no coincidence that more lenders are introducing consumer-friendly features such as fixed rates, zero fees across the board and loan forgiveness policies at a time when federal loan benefits and student subsidies are coming under the knife of a cost-cutting Congress. Furthermore, November’s failure of the Congressional “super committee” to come to an agreement on plans to trim the nation’s deficit by their assigned $1.2 trillion over ten years has cast an even darker shadow of uncertainty on federal programs across the board.

The Budget Control Act of 2011 created the super committee as part of a package to increase the national debt ceiling. The Budget Control Act also significantly impacted student aid, through the elimination of the in-school interest subsidy for graduate students and the elimination of direct loan repayment incentives. With the prospects of automatic, across-the-board cuts to certain government programs in 2013, it’s not out of the question that additional savings measures – at the expense of borrowers – may soon again surface in the Direct Loan program.

All that said, let’s look at what we know for sure: for parent and graduate PLUS borrowers, all approved loans carry a 7.9% fixed interest rate over a ten-year repayment period. The up-front fees, currently 2.5% of the disbursed amount with 12 consecutive months of on-time payment, will increase to 4% as of July 1, 2012. This means that borrowers (and schools) will only receive 96% of the loan value, although they’ll repay 100% of it with interest.

Private loans, on the other hand, are gearing up for a head-to-head fight, at least for those borrowers and co-signers with good credit. The financial markets were not conducive for fixed-rate private student loan offerings just two years ago. While the global economy is hardly out of the woods when it comes to the recession, it has nonetheless improved to the point where many lenders have, or soon will, unveil their own versions of fixed rate products.

Many products now carry fixed interest rates substantially lower than those of Direct Loan PLUS even before back-end repayment incentives, including discounts for graduation, GPA and/or automated monthly payments, are applied. Lenders have largely eliminated loan fees, which can further lessen the true cost of borrowing when compared to Direct Loan PLUS. Finally, and most recently, many private student loans now carry a loan forgiveness feature that releases the co-borrower of all obligations if the primary student borrower becomes deceased or permanently and completely disabled.

What does all of this mean for financial aid officers? Simply put, the true cost of education, when spread out over the repayment term for those who borrow, will vary greatly among students and families. Those fortunate enough to have credit-worthy co-borrowers will not only succeed in filling their funding gap, but they’ll do so at a cheaper rate compared to those with marginally good credit and/or those who choose the federal PLUS route.

Lastly, the financial aid office must also brace for a likely increase in PLUS credit denials in 2012-13. The Department of Education has recently modified credit criteria for PLUS to now include unpaid collection accounts and charge-offs as part of the credit review. Items such as being 90 days delinquent on any debt as well as bankruptcy discharges, foreclosures and wage garnishments during the previous five years will now trigger denials for many who may have been approved in 2011-12. These changes bring the Direct PLUS approval process more in line with what FFELP lenders had in place in recent years. The net result is that many students will seek a qualified co-borrower on a private loan if the additional unsubsidized Stafford loan does not fill their funding gap.

As singer-songwriter Rosann Cash once penned, “the key to change…is to let go of fear.” If your office believes in the value of providing loan counseling advice that will ultimately save borrowers money, then the fear of private loans should be fleeting. The resulting change in perspective will serve to benefit borrowers and schools alike.