Learn the Ins and Outs of Student Loans and Parent Loans for College

The Squeeze

• Both private lenders and the Department of Education offer loan options designed to let parents help pay for their child’s education.
• Unlike federal student loans, federal parent PLUS loans require a credit check and have less flexible repayment options.
• Creditworthy parents can help students qualify for private student loans by co-signing on the loan, usually with the option to release the parent’s responsibility a year or two into repayment.

As your future college freshman begins to dream of campus life, we won’t be surprised to hear that you are already fully grounded in the reality of how to pay for it.

That reality is even more sobering for the Sandwich Generation, caught between two ends of our family — our kids and our parents — who need our support even as we try to secure our own retirement plans.

With so many responsibilities pulling you in different directions, putting funds away for your child’s higher education may not have been priority No. 1, and that’s okay. Really. Want to help your child pay for college but don’t have the savings to cover it? Don’t fret; we’ve got options for you. 

And yes, we’re talking about loans. Today, most students (62 percent) graduate with some loan debt (at an average of $28,950); meanwhile, many parents borrow specifically to pay for college as well. If you’re considering taking on debt to pay for college, here’s what you need to know to make the right decisions for your family.

Types of College Loans for Students and Parents

Firstly, know that there are two major categories of loans to pay for college: federal loans backed by the U.S. Department of Education and private loans issued by banks and other private lenders. Under each of those umbrellas are loans the student can borrow in their name and loans you can borrow as a parent on the dependent student’s behalf. 

Here’s a quick overview of your options.

Federal Student Loans

Students attending any accredited college or university can apply for federal financial aid by filling out the FAFSA each year.

Based on that application, a school might offer the student non-borrowed aid, including grants, scholarships and work-study, as well as two types of federal student loans:

• Subsidized: These loans are for students with financial need. Their perk is that the government covers interest that accrues while a student is in school, saving the borrower a little bit of money on the lifetime cost of the loan.
• Unsubsidized: Students don’t have to demonstrate financial need for these loans. The borrower is responsible for interest that accrues while they’re in school — though, like nearly all student loans, they aren’t required to start making payments until after they leave school.

Interest rates for federal loans are set annually by Congress and are the same for all borrowers.

Federal student loans come with a variety of flexible repayment options you won’t see with almost any other kind of debt. In addition to deferring repayment until after school, borrowers could be eligible for income-driven repayment plans, loan consolidation, future deferment or forbearance of payments, and even loan forgiveness.

Parent PLUS Loans

As a college student’s biological or adoptive parent, you can apply for a Direct PLUS loan in your name to pay for the student’s education.

You can borrow up to the total cost of attendance for the student minus any other financial aid the student gets. Basically, this loan is meant to cover education costs if the student’s financial aid award falls short.

Even though the federal government backs them, PLUS loans act more like private loans than typical student loans. You have to pass a credit check to qualify for the loan, and you’ll pay a loan fee to receive it. The repayment period starts as soon as the loan is disbursed, but you have the option to defer payments until the student is out of school. 

One big difference to note: Interest rates for PLUS loans are set annually, just like other federal loans, and are the same for all borrowers.

Private Student Loans

If your child isn’t eligible to receive enough federal loans to cover their education costs, they can apply for private loans to fill the gaps.

Private loans are administered directly through banks or other financial institutions, including online lenders specializing in student loans. To be approved, borrowers have to apply and pass a credit check for the loan. Each borrowers’ loan amount, repayment terms and interest are set based on creditworthiness and other individual factors.

Young adults might have trouble qualifying for a private loan if they have no credit history. If you have a more favorable credit score, you can help your child get private funding for college through:

• Parent loans Some student loan lenders offer parent loans. These are a private version of the PLUS loan. They work like a student loan to cover your child’s education expenses, but the debt is in your name, not theirs. Repayment might start immediately, or you might be able to defer payments until the student leaves school.
• Co-signing a loan A common way for a student with a less than ideal credit history or no credit history to qualify for a loan is to use a creditworthy co-signer — usually a parent. When you co-sign, the loan is in both your name and the student’s, so you’re equally responsible for the debt. Most private lenders include an option to release co-signers after a year or two of on-time payments and proof of income from the student to show they can fully assume responsibility for repaying the debt.

Other Parent-Driven Funds and Loans

If you or the student can’t qualify for sufficient student loans to cover their education costs, you have other options to help them out — but please consider these carefully before going this route.

You can help your child cover education and living expenses for college through available funding sources, including: 

• 401(k) or IRA distributions: Some 401(k) plans and Roth IRAs let you withdraw money from a retirement account without penalty if you use the money for education expenses, including for your child. The drawback is not having this money for retirement — even if you catch up on your savings later, you’ll have missed out on years of earning interest.
• 401(k) loans: If your plan allows it, you can take out up to 50 percent of your 401(k) balance as an interest-free loan, as long as you can repay it within five years. A huge benefit is you don’t have to pass a credit check to qualify since you’re borrowing from yourself. The drawback is missing out on years of interest on the borrowed amount and the risk of paying taxes and penalties if you can’t repay the amount within five years.
• Personal loans: You could apply for a personal loan from a private lender to help your student cover expenses. However, this option doesn’t make sense in most cases because most borrowers who could qualify for a personal loan would also be eligible for a private student loan, which would come with more favorable terms.
• Other debt: You could assume other types of debt in your name to help your child with living expenses. Think: title loans or credit card debt. No financial expert would advise this. Neither do we because these types of debt are risky and usually high-interest, so they pose significant risks to your personal financial wellbeing.

No matter the type of loan, you should practice caution if you decide to take on debt to pay for your child’s higher education. 

Besides the obvious disadvantages of taking out parental loans, there are other factors to consider. For instance, while your child’s direct student loan debt will be eligible for deferment and income-contingent repayment plans making them more manageable to repay, your parental loan burden will not. 

Additionally, your student may be able to qualify for student loan forgiveness. Even with federal Parent Plus Loans, there are far fewer options for debt forgiveness. Lastly, every dollar used to pay this debt is one you can not put towards your retirement, so consider these college-funding strategies carefully to make sure that they’re right for you.