Should parents use a PLUS or home equity loan to help pay for college? | Store student loan

Paying for college can be a challenge for many families. Even those who are diligent savers may still need more funds after applying available savings, scholarships, and grants and maximizing direct federal student loans. In such cases, many parents consider additional loan options like private student loans, the Federal Parent PLUS Loan, or a home equity loan to fill the gap.

Home equity loans allow homeowners to take out a line of credit against the value of their home beyond what they owe on their primary mortgage. Unlike a cash-out refinance, a home equity loan does not replace the mortgage you currently have and allows you to borrow the exact amount you need to cover tuition, in some cases without having to pay any fees. closing costs.

Over the past few years, property values ​​in many markets have risen dramatically, putting many homeowners in a position to utilize this financing vehicle.

At the same time, higher interest rates on the Parent PLUS loan could make alternative financing options, like private student loans or home equity loans, more attractive to many families.

The U.S. Department of Education recently raised the Parent PLUS loan interest rate to 6.28% for loans first disbursed on or after July 1, 2021 and before July 1, 2022, from 5.3% the previous year. Current home equity loan rates generally range from around 3% to 12% depending on the lender, the amount of the loan and the creditworthiness of the borrower.

Here are some of the pros and cons of using a home equity loan instead of a Parent PLUS loan to pay for college.

Creditworthy homeowners can get home equity loans with a better interest rate than the Parent PLUS loan. The Parent PLUS has the same fixed interest rate for every borrower, regardless of credit history, but those with good credit can often find better interest rates on a home equity loan.

Lower interest rates can mean parents can have lower monthly payments and save money over time as their student loan is paid off.

For example, in 2021, the average Parent PLUS loan borrower owed nearly $29,000. The loan origination fee is currently 4.228%. At an interest rate of 6.28%, paying off $29,000 under a standard 10-year repayment plan would be approximately $326 per month. This includes approximately $10,126 paid in interest. Adding the total of approximately $1,226 in origination fees that were automatically taken from each loan disbursement, the total cost of Parent Plus loans would be approximately $40,350.

If that same parent borrowed a home equity loan for the same amount with an interest rate of 5%, the payments would be about $308 per month over 10 years. For a loan with no origination fees, the total cost of the loan would be $36,960, which is more than $3,000 less than the Parent PLUS loan.

Be sure to look for home equity loans with no closing costs or annual fees. Also keep in mind that better interest rates will depend on your credit score.

Plus, home equity loans can also be the most tax-efficient option for parents. On federal tax returns, a parent can deduct up to $375,000 in interest per year for qualifying home equity loans — or $750,000 if jointly filed — against a maximum of just $2,500 per year. for qualifying Parent PLUS loans.

If you can save money and lower your monthly payments by taking out a home equity loan rather than a Parent PLUS loan, paying for college with a home equity loan might seem like a no-brainer. But parents should be aware that there are more risks associated with these loans.

First, when parents borrow against their home, they are essentially gambling their home to pay for their education. This is because when you take out a home equity loan, your home is pledged as collateral. If a loan is not repaid, your house can be repossessed.

There is also the risk of becoming “upside down” on the home if the value of the properties declines. This happens when more money is owed on the house than it is worth. If the housing market weakens and the value of your home drops, you could end up with more debt than equity.

In terms of repayment, neither the home equity loan nor the Parent PLUS loan are generally eligible for the generous income-based repayment options available for some direct federal student loans. Currently, payments and interest on most existing Parent PLUS loans are automatically suspended until May 1 as part of the pandemic-related CARES Act enacted in 2020.

Families with good credit looking to save money may also find lower interest rates on private student loans, which may carry less risk, especially since they typically don’t use homes. as a guarantee.

Also, most private student loans are issued to the student, who will benefit from the education, with a parent possibly listed as an endorser, who is a type of co-signer. This can prevent parents from being buried in college debt as they approach retirement.

Despite rising costs each year, college is still one of the best investments families can make in the future. Your best resource for navigating through loan options is your college or university’s financial aid office. The staff will be able to explain all of your options and how to apply for different types of student loans.