The Dangers of Taking out a Direct PLUS Loan

Imagine this scenario: Your son or daughter has been out of college for over a decade and moved on to a successful career. Your own career is coming to a close and retirement is only a few years away. And yet, you still owe thousands of dollars for your child’s college bills.

This scenario is a reality for many parents who take out federal Direct PLUS loans. While these loans might seem like an easy way for parents to help their child with education costs, in far too many cases, they put the parent’s financial security and retirement at risk.

How PLUS Loans Work

PLUS is an acronym for Parent Loan for Undergraduate Students. (There is also a grad PLUS program for graduate and professional students borrowing on their own.)

The parent PLUS program allows parents to borrow money for dependent students to pay any costs not already covered by the student's financial aid, such as Pell Grants, student loans, and paid work-study jobs.

PLUS loans have fixed interest rates for the life of the loan. They are typically repaid over 10 years, although there is also an extended payment plan that can lengthen the term up to 25 years.

Parent PLUS loans are the financial responsibility of the parent rather than the student. They can't be transferred to the student, even if the student has the means to pay them.

Danger 1: There Is No Automatic Grace Period

When a student takes out a loan, they typically have six months after graduation to start the repayment process. Not so with PLUS loans. The repayment period starts immediately after the child or school receives the money; however, parent borrowers can contact the loan servicer to request a deferment while the student is enrolled at least half-time and for six months after they leave school.

Danger 2: PLUS Loans Aren't Eligible for Most Income-Driven Repayment Plans

The federal government offers four different income-driven repayment plans for student loans. They limit monthly payments to a percentage of the student's discretionary income (generally 10%). If the student makes those payments for a certain number of years (typically 20 or 25), any remaining loan balance will be forgiven.

Parent PLUS loans, however, are eligible for only one of these plans, Income-Contingent Repayment (ICR), and only after the parent has consolidated their parent loans into a federal direct consolidation loan. An ICR plan limits payments to no more than 20% of discretionary income, to be paid over a term of 25 years—which is a long time horizon for the average parent.

Danger 3: You Can Easily Borrow More Than You Need

When you apply for a Direct PLUS loan for your child, the government will check your credit report, but not your income or debt-to-income ratio. In fact, it does not even consider what other debts you have. The only negative thing it looks for is an adverse credit history.

Once you're approved for the loan, the school sets the loan amount based on its cost of attendance; however, a school’s cost of attendance is usually more than most students actually pay. This can lead to parents borrowing more than their child needs for college.

If you have other outstanding debt, such as a mortgage, you may find yourself in over your head when it comes time to repay the PLUS loan.

Danger 4: They're Impossible to Get out of, Even in Bankruptcy

There is no escaping a Direct PLUS loan, so not making payments and letting a PLUS loan go into default is a huge mistake. Even declaring bankruptcy will not dismiss the debt. Until the debt has been repaid, the government can garnish your wages, or withhold money from your Social Security benefits and tax refunds. What's more, there are no time limits for when the government can collect the debt.

So before you even consider defaulting, contact your loan servicer for advice, or seek out an attorney who specializes in student loan debt.

What's more, unlike Sallie Mae loans, you won't be able to have a PLUS loan balance forgiven if your child is later faced with total permanent disability (TPD).

What to Do Before You Take a PLUS Loan

Many times, a school will present the student's financial aid package with a Direct PLUS Loan added in. The school might say that it wants to make families aware of all of their available funding options, but including the Direct PLUS loan in the package can make the true cost of college confusing. When considering the costs of college, ask for a financial aid package breakdown without the PLUS loan.

Instead of a Direct PLUS loan, you might have your child opt for a private student loan for any leftover costs that grants, work-study, federal student loans, scholarships, and other aid do not cover. If you want to help your child financially, you can make payments on the private loan while they are still in school. This allows you to subsidize your child’s college costs but doesn't hold you solely accountable for the debt.

What to Do if You Have a PLUS Loan

If you took out a Direct PLUS loan for your child's education and are struggling to pay it back, consolidation (as described above) might be an option. Be aware, though, that while increasing the length of your loan will decrease your monthly payments, it will also increase the total amount you will have paid by the end.

Refinancing the PLUS loan is another possibility. In fact, even if you are not struggling to repay your loan, it's worth looking into refinancing to see if you can secure a lower interest rate and monthly payments.

The smartest financial move is to try to pay as much as you can toward the loan while you're still earning money, even if it means you have to tighten your budget, and not take it with you into retirement.

Also, try to avoid borrowing against your retirement funds, such as 401(k) plans, or cashing out of them early to cover the loan costs. Instead, if you are nearing retirement, consider working a few more years, if you are in any position to do so, to pay off the loan before retirement.

Frequently Asked Questions

The Bottom Line

Helping your child with the cost of college is a noble thing to do, but not if it lands you in a difficult spot financially or puts your retirement at risk. Ultimately, your child will have several decades to pay off their student loans before they retire, and their loans—unlike parent PLUS loans—may be eligible for loan forgiveness programs and more generous income-driven repayment plans.