Federal Plus Loan vs. Home Equity Loan

Parents face difficult decisions when deciding how to finance their kids' college education. Generally, parents will find it possible to borrow as much money as might be needed, but the choices available as numerous. One popular discussion is whether you should pay for college expenses with a federal Plus loan vs. home equity loan or line of credit.

Paying With a Home Equity Loan
A home equity loan has a few distinct advantages in financing a college education. First, all interest paid on a home equity loan, much like interest paid on a student loan debt, is tax deductible. Therefore, should you meet the standard deduction requirements with other deductions, all of your home equity loan interest will be subsidized with a tax benefit.

Additionally, home equity loans tend to have low interest rates as second mortgages, and lower, but variable rates as home equity lines of credit. First, consider that a second mortgage can be written as an amortizing loan in which you make routine monthly payments for a predetermined number of years. In such a scenario, you can opt for a fixed interest rate loan term that will allow you some certainty in the amount you pay each month.

Lines of credit, on the other hand, are more expensive, mostly because they have interest rate caps which can be much higher than a fixed rate loan. In the case of a line of credit, you have no regular monthly payment besides a minimum payment, which will typically amortize the full balance in 20 years or longer. But you also have some risk. In seeking out a line of credit against your home equity, you might just find that the loan’s interest rate varies with a change in interest rates. Should you borrow money to finance an education at 5%, but rates rise 3%, then your new interest rate is 8% annually, which will increase your monthly payments, and speed up the power of compounding interest.

Finally, the last concern with a home equity loan is that a parent Plus loan allows you to push off monthly payments in case of hardship, whereas your bank might not let you do the same with your home loan. Additionally, a parent Plus loan is discharged should a borrower become disabled or die, whereas a home loan is not.

Parent Plus Loan
Parent plus loans have a few benefits, as well as a few downsides.

First, a very big concern for borrowers should be that you can never wipe away federal student loan debt. Even people who fall into bankruptcy must, at all times, make repayments on their loan until it is paid in full. If your young scholar doesn’t find a job, and can’t help out on the loan payments, be sure that you have enough money to pay them yourself, as you absolutely have to!

But there are some benefits to a parent Plus loan: a parent Plus loan has a fixed rate of interest, which is 7.9%. This rate is set by Congress only for new loans, and your loan will always be fixed at the interest rate that was assigned to the Plus program for that year by congress. Do consider that you will pay 4% of the loan balance in origination and default fees, which help cover other costs of the program.

You can reduce your monthly payments and total interest rate by signing up to pay a student loan automatically. With a parent Plus loan, a .25% credit will be added to your interest rate, thus making a 7.9% rate a 7.65% rate if you use a checking account to make automatic payments. Over the long haul, this interest rate credit can add up to thousands of dollars in interest savings.

Finally, there is no collateral necessary for a parent Plus loan, whereas a home equity loan is secured by your home. Keep in mind that home equity loans can make it difficult to move, and may come back to bite a homeowner who sells their home for an amount less than their existing credit lines. It would be recommended to anyone that they carefully consider their current equity balance, their borrowing opportunities, and always seek to keep loans on the students’ names, rather than the parents’.

Remember that you are borrowing for your student, not for yourself. However, you, as the borrower, are responsible for the monthly payments, regardless of how they use their education. While it may seem ridiculous to plan for a child’s future unemployment, drop out, or other problems, things can, and do, happen. Always do your best to ensure that your student is well funded, but do not bear unnecessary risks in making your child’s education a reality. A better option might be to cosign for a private loan for your student, with the intention of removing your name as a cosigner 1 year after their graduation.