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Weigh Pros, Cons of Using a Private Parent Loan to Pay for College

Farran Powell

Jeanne Cromwell and her husband paid for their two older children's education with a direct parent PLUS Loans and expected to do the same for their youngest Kathleen -- but when the financial aid package came up short, the couple took out a private loan.

"We were offered a PLUS loan for the fall, but it wasn't part of the part of the financial aid package for the spring," says Cromwell, who is also paying off a consolidated student loan for her older children who have already graduated.

The family borrowed from SoFi, a San Francisco-based financial technology company that offers student loans, to finance their daughter's attendance at Franklin and Marshall College -- a private college that costs $50,400 annually in tuition and fees.

While Cromwell says she's happy with the near 5 percent fixed interest rate on the loan, she would prefer a federal loan because of the repayment options.

"We'll take federal loans if we're offered them because the repayments are more flexible. We can refinance when she graduates," Cromwell says.

With the increasing cost of education, more parents are turning to private lenders to fund their child's education, experts say.

[Strategies for repaying Parent PLUS loans.]

"Parents are playing more of an outsized role in helping their kids pay for college," says Carlo Salerno, a District of Columbia- based education economist.

Here are some of the pros and cons of taking out a private parent loan for education.

Pro: Most private loans offer a lower interest rates compared with federal Parent PLUS loans.

Most parents use this type of loan to send a child to a private nonprofit college, Salerno says.

"We're talking a small sliver of the population that is going to a for-profit or nonprofit private college," the education economist says. "And they are having to borrow so much money because the amount they get from the federal government won't cover it."

Many traditional large commercial banks such as Bank of America and JPMorgan Chase discontinued offering student loan products to parents several years ago -- leaving a gap in the market for nontraditional lenders, banking experts say.

[Learn how to avoid the college savings mistakes that cost parents money.]

New private parent loan lenders, from Sallie Mae and SoFi to College Avenue Student Loans, offer lower interest rates than a federal parent loan. A d irect Parent PLUS loan is fixed at a 6.84 percent interest rate.

And some lenders offer even lower interest rates than the federal parent loan. A fixed interest rate at SoFi, for example, can be as little as 4.25 percent, depending on the borrower's credit.

"Our product offering to parents has proven to be extremely popular. We have lent hundreds of millions of dollars," says Dan Macklin, co-founder of SoFi, which started offering this type of loan in early 2015.

[Learn about refinancing Federal Parent PLUS loans.]

And Sallie Mae, best known for its private loans to students, launched a product for parents on April 18 with fixed interest rate, starting at 5.74 percent.

Con: Private loans are less flexible than federal loans in repayment terms.

Ten percent of parents use PLUS loans to pay for their child's college, according to 2015 College Board report. A significantly smaller percentage take out private PLUS loans, experts say.

One caveat : Parent loans don't have the same repayment schemes as those for federal student loan borrowers. There is no income-based repayment plan for a federal parent loan, for example.

Pro: Private parent loans have no origination fee.

Private parent loans on the market may have other restrictions -- such a required minimum amount for borrowing -- but origination fees aren't included. A Direct Parent PLUS Loan comes with a 4.27 percent loan fee.

If a parent takes out a $10,000 federal loan, the loan fee is $427. So the total amount borrowed is $9,573 plus accumulating interest.

Con: Low interest rates are only for borrowers with good credit.

"There's a very minimal check that goes into PLUS, but that's all you need to access the loan and people feel comfortable taking out a government loan," Salerno says.

Parent loans borrowers with poor credit history are unlikely to secure a good interest rate for a private loan and will be offered much higher interest rates, student loan experts say. In some cases, those interest rates can go up to 13 percent -- much higher than a PLUS loan.

"One of the criticisms that's going to emerge is that the parents who are taking these loans are going to be the parents with good credit ratings," says Salerno.

Trying to fund your education? Get tips and more in the U.S. News Paying for College center.

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