Parents looking to borrow money to help pay their kids' college tuition bills often turn to PLUS loans from the federal government or home equity loans from private lenders. Both types of loans have their advantages and disadvantages, and the best type of loan for any given family will depend on their financial situation.
In general, parent PLUS loans have higher interest rates than home equity loans. As of 2011, PLUS loans have a fixed interest rate of 7.9 percent. Home equity loans have an average national interest rate of 7.15 percent, and home equity lines of credit have an average national interest rate of 5.56 percent. Parents with excellent credit scores might be able to get even better rates. However, home equity lines of credit usually have variable interest rates, so the rate could increase and end up costing more than a PLUS loan in the future. Although parents could get a fixed-rate home equity loan instead, this loan comes in one lump sum, which is not ideal for paying tuition each semester.
The amount a parent can borrow with a home equity loan or line of credit is generally capped by the home's value. Lenders will rarely allow homeowners to borrow more than the home is worth, and they will often cap borrowing at 80 to 85 percent of the home's value. This means that some parents might not have enough home equity to cover all four years of college costs for all of the children. PLUS loans, on the other hand, are capped at the cost of attendance minus any other financial aid received. This means that the parents can borrow their full out-of-pocket cost for their kids' college tuition, room, board and fees.
Home Equity Dangers
Taking out a home equity loan or line of credit can be a risky move for parents. The home is likely one of their biggest assets, and borrowing against it reduces the equity they have built up over many years of mortgage payments. If the home's value drops, parents could find themselves owing more on their home than it is worth. In addition, if the parents encounter financial trouble and cannot make the home equity loan payments, the lender could foreclose on their home. PLUS loans, on the other hand, have provisions for deferment or forbearance in times of economic hardship.
For many parents, the PLUS loan is a smarter choice because it has a fairly low fixed interest rate and does not put the family home at risk. However, parents who are financially secure, have solid retirement savings outside the home and have built up significant equity in the home might be better off with a home equity loan. This has a lower interest rate than a PLUS loan and has the additional advantage of reducing the parents' assets, which could result in the students receiving more financial aid in future years.