This decision has a huge impact on your financial future. Here's what you need to know to make the right call.
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Getting into college was the first hurdle. Now you have to figure out how you're going to pay for it. After exhausting scholarships, grants, and personal savings, most people turn to student loans. But that raises even more questions. Which type of student loan is best: federal or private? And who should take out the loan in the first place?
It's usually better for students to take out student loans themselves, rather than parents taking out loans on behalf of their child. But every situation is different and it's up to each family to determine the right move for them. Here's an overview of student and parent student loans to help you make your decision.
Federal student loans
Federal Direct student loans are loans from the federal government taken out in the student's name. They're the most popular type of student loan because they offer flexible repayment options, some of the loans may be subsidized, and there are few qualification requirements so students don't need a cosigner to be approved.
But you're limited in the amount of federal student loans you can borrow. The amount varies by your year in school and your dependency status. You're considered an independent student if you're 24 or older, married, a graduate or professional student, a veteran or a member of the armed forces, an orphan or ward of the court, caring for dependents of your own, an emancipated minor, homeless, or at risk of being homeless. If none of the above apply to you, you're considered a dependent student.
Independent students and dependent students whose parents do not qualify for a parent PLUS loan -- because they're not your biological or adoptive parents, they have an adverse credit history, or they're not U.S. citizens or permanent residents -- may borrow more than dependent students. Here's a chart listing the current borrowing limits by year and dependency status:
Year in School
Independent Students and Select Dependent Students
$5,500 (no more than $3,500 subsidized)
$9,500 (no more than $3,500 subsidized)
$6,500 (no more than $4,500 subsidized)
$10,500 (no more than $4,500 subsidized)
Third-Year and Beyond Undergraduate
$7,500 (no more than $5,500 subsidized)
$12,500 (no more than $5,500 subsidized)
Graduate or Professional Student
$20,500 (unsubsidized only)
Data source: U.S. Department of Education.
If your loan is subsidized, that means the government pays your interest while your loan is in deferment. You can file for deferment under select circumstances, like enrollment at least half-time in school or for financial hardship, and if you're approved, you won't have to make any loan payments during this time. Forbearance is similar, but has more flexible qualifications. You can also get a forbearance with federal student loans, though the government will not pay the interest on your loans during forbearance. Unsubsidized federal student loans are also eligible for deferment or forbearance, but your loan balance will accrue interest in both cases.
One of the reasons federal student loans are so popular is because they have the most flexible repayment options. You can choose from:
- Standard Repayment Plan: You pay a fixed amount every month for 10 years.
- Graduated Repayment Plan: You still pay off your loan in 10 years, but your payments start out lower and increase every two years.
- Extended Repayment Plan: You pay back your loan over 25 years, but you must have $30,000 or more in federal student loans to qualify.
- Revised Pay as You Earn (REPAYE) Plan: Your monthly payments are 10% of your discretionary income -- the difference between your income and 150% of the poverty guideline for your state and family size. Payments are re-evaluated each year.
- Pay as You Earn (PAYE) Plan: Your monthly payments are 10% of your discretionary income, but will never exceed what you'd pay under the standard repayment plan. Payments are re-evaluated each year.
- Income-Based Repayment (IBR) Plan: Your payments are 10% of your discretionary income (or 15% if you took out your loan before July 1, 2014) but will never exceed what you'd pay under the standard repayment plan. Payments are re-evaluated each year.
- Income-Contingent Repayment (ICR) Plan: You pay the lesser of 20% of the difference between your income and the poverty guideline for your state and family size or the amount you'd pay with a fixed, 12-year repayment plan. Payments are re-evaluated each year.
Depending on what field you're in, you may also qualify for Public Service Loan Forgiveness (PSLF). If you fill out the appropriate paperwork, work for a qualifying organization for at least 10 years, and make 120 on-time federal student loan payments under a qualifying repayment plan, the government will forgive any outstanding student debt.
Federal parent student loans
Federal parent student loans, also known as Direct PLUS loans, are loans taken out in a parent's name on behalf of their child. They're similar to federal student loans for students, but they have less flexible repayment terms and the interest rates are typically higher.
Interest rates vary depending on when you take out a federal student loan. Undergraduates who take out a student loan between July 1, 2018 and July 1, 2019 will only have a 5.05% interest rate while parents who take out a Direct PLUS loan will have a 7.6% interest rate. This makes taking out a loan on behalf of your child more costly than letting him or her take out a loan independently.
It's not a smart move if you doubt your ability to keep up with the payments. Parents only have their choice of the standard, graduated, extended, and income-contingent repayment plans, and they're limited to the standard plan unless they consolidate their Direct PLUS loans into a Direct Consolidation loan. This means taking on a new loan with a higher balance -- because what were once interest charges now become part of the principal balance -- and possibly a higher interest rate. Direct PLUS loans do allow for deferment or forbearance if you fall on hard times, but there are fewer options for parents to qualify and if they do, the government won't pay the interest during the deferment period.
A Direct PLUS loan could be a good choice if you're trying to reduce the amount of debt your child takes on and you can comfortably make the payments or you believe you'll qualify for PSLF. It's also a good fit if you need to borrow a large amount above and beyond what your student can take out in his or her own name because the only restriction on how much money parents can borrow is the cost of attendance of their child's school.
Private student loans
If your child has borrowed up to his or her federal student loan limit and parents are unwilling or unable to take out a Direct PLUS loan, a private student loan is another option. These are student loans issued by private lenders and terms vary from one lender to the next. There usually aren't any restrictions on how much you can borrow other than the school's cost of attendance, but qualification requirements are usually stricter.
The lender may require your child to have a certain credit score or be able to demonstrate a certain level of income that he or she may not have. In that case, you may need to cosign with your child in order to help him or her get the loan. Your child will still be primarily responsible for the loan, but if he or she is unable to keep up with the payments, you will have to make them or else both of your credit scores will suffer. Some private student loans may enable you to refinance the loan in only your child's name once your child has proven to be a responsible payer, but you should verify this with the lender before agreeing to cosign the loan.
Though less common, some lenders also enable parents to take out student loans in their own name on behalf of their child. This could end up being more affordable than Direct PLUS loans, depending on how good your credit is.
But cost isn't all you need to pay attention to when taking out a private student loan. Look into its repayment options and see whether it allows for deferment or forbearance if you fall on hard times. These can make a big difference in how easy it is to keep up with the loan payments.
Which type of student loan is best for my family?
Parents and students should sit down together and discuss how they plan to finance the child's higher education. Figure out how much you need to borrow and decide who is going to foot the bill. In most cases, it's best for the child to take out the loan in his or her own name, both because loan terms for students are usually more flexible and because if the parent cannot keep up with the loan payments, it could make it difficult or impossible for them to save for their other financial goals.
Parents of college-age children usually have their eyes on retirement and it's important that they prioritize saving for this first because if they run out of money in their old age, their child will have to support them, and this may cost the child more than a student loan would. So if the parent is behind on retirement savings or is unsure of his or her ability to pay back the loan on time, it's better to let the student take responsibility for the debt.
If the parent isn't comfortable placing such a heavy burden on the child, the two may decide to split the loans. The child may take out what he or she can in federal student loans and then if that's not enough, the parent may make up the rest with a Direct PLUS loan.
Whichever strategy you choose, make sure both parties are comfortable with the costs and understand their repayment options and opportunities for deferment, forbearance, and student loan forgiveness. Once you take out a student loan, there's no going back so you want to make the right decision the first time.
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