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Parents: Think Hard Before Borrowing for, With Your Student

Betsy Mayotte

Finding the right balance of access to college and manageable debt is an exercise that many families practice right around this time of year -- when the tuition bill shows up. Even a great financial aid package can fall significantly short of the total bill, which means it's time for some tough decisions.

Earlier this month, the Department of Education issued new, draft rules that, if adopted, will change the eligibility criteria for both graduate and Parent Direct PLUS loans. The Student Loan Ranger attended the meetings where the department worked with members of the financial aid and consumer advocate communities to develop a policy that both maintains access to higher education and helps protect borrowers from taking on more than they can handle.

This week's blog looks at some of the options available for parents of undergraduate students and some tips to ensure smart choices.

[Find out the truth behind the student loan bankruptcy myth.]

-- Tuition payment plans: If you can afford it, your best bet is to work out a payment plan with the school where you pay the remaining tuition costs off monthly over the school year. These plans are generally interest-free, but can have some small fees, usually under $100.

In the long run this is the most cost-effective option, but note that if you fall past due, your child may not be allowed to sign up for classes or receive his or her diploma or transcripts until the bill has been paid.

-- Federal Parent Direct PLUS loans: If you are the parent of an eligible undergraduate, you may be able to borrow a Parent PLUS loan to cover the remaining cost of attendance after the other financial aid kicks in.

There is no annual loan limit for PLUS loans and you can borrow up to the cost of attendance minus other aid, so this can be an easy solution to fill the tuition gap no matter how big. While there is a credit check, it's fairly mild and you have the opportunity to get an endorser if you don't pass the initial credit check. If you don't have a creditworthy endorser and you are denied the loan, your child will be eligible for additional unsubsidized Stafford loans based on the denial.

[Take a look at potential changes to Parent PLUS loans.]

But parents need to think a borrowing decision like this through to graduation and beyond, before signing off on that first loan. A $20,000 loan for freshman year may sound manageable, but multiply that by the number of years you expect your student to be in school and the number of college bound children in the household and suddenly you owe $160,000 in Parent Direct PLUS loans, assuming you only have two children.

That works out to about a $1,800 monthly payment under a standard 10-year plan. Parent PLUS loans aren't eligible for most income-based repayment options, although they can obtain access to income contingent repayment if they consolidate the loans under the Direct Loan program.

But even under this plan, a family of four with a combined adjusted gross income of $80,000 will still have a monthly payment of around $1,000 a month -- paying back a total of more than $300,000 including interest. Loan debt like this can affect retirement savings, or even retirement itself.

Many families make an arrangement with the student that while the parents will take out the loan, the student will repay them. Just remember that the loan can never be changed to the student's name, and all lower payment, deferment and discharge options are based on the parent's situation, rather than the student's.

-- Co-signing a loan: A lot of parents don't want to take on the Parent PLUS debt in their name. In some cases, that's to ensure the student holds the responsibility for the debt, and in others it's parents not wanting to affect the debt to income ratio on their credit report.

Instead, they have their children apply for private student loans to make up that tuition gap. The problem with this strategy is that 90 percent of private student loans have co-signers and many times, those turn out to be the parents.

Co-signing a private student loan usually means that you are equally responsible for the debt, and in most cases, that debt will show up on your credit report even if it has always been paid on time, therefore affecting your debt-to-income ratio.

[Here are five questions to ask before signing a promissory note.]

As private loans have very few lower payment or other options if the borrower cannot pay, and may not have discharge provisions if the borrower should pass away or become disabled like federal loans have, it can actually be riskier for the parent to co-sign on a private loan than it would be for them to take out the federal PLUS loan under their own name.

-- If you do borrow, reduce the overall bill: Federal Parent Direct PLUS loans and many private loans are usually deferred while the student is in school. You can save significantly over the life of the loan by at least paying the interest that accrues while the student is in school. If you can make regular payments while they are in school, even better.

Borrowing for your child's education may be the right decision for your family. Just make sure that you find the right balance between access and affordability.

Betsy Mayotte, director of regulatory compliance for American Student Assistance, regularly advises consumers on planning and paying for college. Mayotte, who received a B.S. in business communications from Bentley College, is a frequent contributor to ASA's SALT Blog; responds to public inquiries via the advice resource "Just Ask;" and is frequently quoted in traditional and social media on the topics of student loans and financial aid.