Here's What to Know About Parent Student Loans

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As a parent, the desire to help your children is innate, so it's understandable if you want to help them pay for college by taking out parent student loans. But borrowing money to help your child get through school can put a serious strain on your financial well-being, as well as your future financial security.

In fact, the federal government estimates that more than 1 in 8 parents will default on their Parent PLUS Loans. If you're considering taking out parent student loans, below are five key considerations to keep in mind before you pull the trigger.

1. It Will Impact Your Credit

Virtually every time you apply for credit, the lender performs a hard inquiry on one or more of your credit reports. If you apply for private student loans on behalf of your child, the hard inquiry can impact your FICO^® Scores. While Parent PLUS Loans through the Department of Education do require a credit check to make sure you don't have an adverse credit history, it's just a soft inquiry and won't affect your FICO Score.

Another thing to consider is that adding a new credit account to your credit report can impact your credit history by affecting the amount of debt you owe and the average age of your credit accounts. If you make miss a payment by 30 days or more, it could damage your FICO Scores significantly. And if you default on the debt, it could take years to recover.

2. It Will Increase Your Debt-to-Income Ratio

Your debt-to-income ratio (DTI) isn't included in your FICO^® Scores, but it's an important factor that lenders may consider when you apply for credit. That's especially true for mortgage loans. Your DTI is calculated by dividing the total amount you pay toward your debt obligations each month by your gross monthly income.

For example, if you have $1,000 worth of debt payments and your gross monthly income is $4,000, your DTI is 25%.

When you add parent student loans to your credit report, the monthly payment may count against you when you apply for a loan. If you're hoping to buy a house, it could reduce the amount you can borrow because mortgage lenders try to keep the total DTI from your existing debt and the new mortgage loan to 43% and under.

In other words, taking out parent student loans could impact your ability to get credit when you need it for yourself.

3. It Will Make it Harder to Save for Retirement

The U.S. Government Accountability Office found that nearly half of Americans age 55 and older have no retirement savings. If you believe you're behind on your retirement plan, taking on parent student loans will only make it more challenging for you to get caught up.

While it might seem selfish to some to focus on their own future instead of their children's, it's important to note that while financing options are plentiful for college students, there are no low-interest retirement loans available for their parents.

If you sacrifice your retirement plan to borrow on behalf of your college-aged son or daughter, it could mean living on less than an amount you're comfortable with, working longer, or ultimately relying on your children for financial support.

4. Parent Loans Are More Expensive

For the 2020-21 school year, Parent PLUS Loans come with a 5.3% interest rate, as well as a 4.228% loan fee, which is deducted from the loan proceeds. In contrast, undergraduate loans carry an interest rate of 2.75% and a loan fee of 1.057%.

If you borrow from a private lender, you can generally avoid an upfront loan fee, but the interest rate will depend on your credit and financial situation. Even with stellar credit, though, it'll likely be difficult to beat the terms of federal undergraduate student loans.

What's more, if your family demonstrates financial need, your child could qualify for subsidized student loans. With these loans, the government pays the interest while your child is in school, as well as during future deferments.

Of course, parent loans also allow you to borrow more than what your child can through the Department of Education. But if they can get enough to cover their educational expenses, the terms are much more favorable if they take out the loans.

5. It Can Be Tough to Transfer the Debt to Your Child

Some parents may take out parent student loans with the intention of transferring the debt to their child once they graduate. And while some student loan refinance companies allow this, your child will need to be able to meet the lender's eligibility requirements to transfer the debt.

While there are some exceptions, most recent college graduates likely don't have a robust credit history, so it could take years to transfer that burden. And if your child doesn't agree to take the debt, you're stuck with it because it's in your name.

To compromise, you may be able to have your child make payments on your loans, but the debt will still be on your credit reports and affect you in other ways.

The Bottom Line

There's nothing wrong with wanting to help your child financially while they're in college. But before you do, it's important to consider how the decision to take out parent student loans can impact you. In many cases, it may be better to encourage your child to apply for federal financial aid on their own.

One way to help without putting your future financial security at risk is to open a 529 College Savings Plan and contribute to it. The funds in this type of account grow tax-free, and there are no taxes on the withdrawals as long as you use them for eligible educational expenses. What's more, some states offer tax deductions or credits on the initial contributions.

Alternatively, you could provide a modest allowance to help your child with certain living expenses that don't fall under the umbrella of approved uses for federal student loans. You may also help your child find scholarships they can apply for and choose a more affordable school.

The important thing is that you take the time to understand how parent student loans could impact you and research alternatives that can help your child get the financing they need without shifting the burden to you.

Ben Luthi

Ben Luthi has been writing about money and travel for seven years. He specializes in consumer credit and has written for several major publications and industry leaders, including U.S. News and World Report, Fox Business, Wirecutter, Experian, and Credit Karma.