By Dr. James M. Dahle, WCI Founder
I hate Parent PLUS loans. And I hate how our higher education system and student loan system causes people to ask very good questions like this one:
Q. My parents graciously took out Parent PLUS loans for my undergraduate education, in my mom's name. I currently have about $150,000 in Parent PLUS loans. My parents are currently paying by “income contingent repayment,” making payments of about $300 a month, covering nowhere near the interest. With my mom retiring in the next couple of years, her income will decrease and the payments should decrease as well. Is there any reason to pay off these loans quickly? The loans are discharged with death (parents will be over 90 years old after 25 years of payment) and the forgiven amount is not taxed and not taken out of my mom's estate. This seems almost too good to be true, do you have any experience with this?
Talk about moral hazard and malincentives. Here is the definition of moral hazard:
“Lack of incentive to guard against risk where one is protected from its consequences, e.g., by insurance.”
The moral hazard is that when people are not responsible to pay loans back (or pay a fair interest rate), they are likely to borrow more. While we are not always the classic homo economicus, we do respond to incentives. Incentivize people to do the wrong thing, and many of them will do it.
But back to the subject at hand, Parent PLUS Loans.
How Parent PLUS Loans Work
A Parent PLUS loan is a loan taken out by a parent (grandparents cannot do it, even if they are the legal guardian, unless they formally adopt the kid) for their child's education. It is a federal loan but not a direct loan. Thus, it is not eligible for any of the good federal programs such as:
- Income-Based Repayment (IBR)
- Pay As You Earn (PAYE)
- Revised Pay As You Earn (REPAYE)
- Public Service Loan Forgiveness (PSLF)
If the borrower or the student dies before the loan is paid off, the remainder is forgiven tax-free. If the borrower (but not the student) becomes permanently disabled, the remainder is forgiven tax-free. A Parent PLUS loan (even just one) can be consolidated into a Federal Direct Consolidation Loan (interest rate rounded up to the nearest 1/8th%) that is eligible for Income Contingent Repayment (ICR). ICR requires payments that are 20% of discretionary income and any amount remaining unpaid after 25 years is forgiven. That forgiveness is taxable at ordinary income tax rates in the year it is received.
Other terms on a Parent PLUS loan are also worse, including fees and interest rates. For example, as of April 2022, the rate on a typical direct student loan for a med student is 5.28%. On a Parent PLUS loan, it is 6.28%. It also has an origination fee of 4.228%.
Parents sometimes also take out private student loans with their own terms—or even borrow against their house, 401(k), whole life insurance policy, or other assets.
Why I Hate Parent PLUS Loans
I don't really like Parent PLUS Loans. I don't even like the idea of a parent loan at all. I think if anyone is going to borrow for a student's education, it should be the student. When you borrow for something, by definition, it means you cannot afford it. If you could, you'd just buy it, at least if it costs 4% upfront plus 7% a year to get the money. I'm all for saving for your child's education. I think it's great that you want to help your child. But you should help them from a position of strength. A parent that borrows for their child's schooling almost surely does not have their retirement on track. You're not doing your child a favor by paying for their education and then having them worry about you for the last 30 years of your life.
This is particularly bad in a case where the child is going to become a doctor or other high-income professional. Now you have parents who perhaps made $80,000 a year and are rapidly approaching retirement borrowing to pay for someone whose income will be $300,ooo. How many retirements have been ruined by Parent PLUS student loans? Here's kind of the classic scenario that I found on Fastweb:
“Help!!! My Parent PLUS loans are presently in a forbearance that will end in a few months. My expected installment payments are more than my monthly income. I am retired and my husband is on disability retirement. We have another son presently attending college. What options are available to me (if any)? Do I ask for an extended repayment, or continue with an economic hardship deferment? My husband was a teacher for 33 years and I was a school nurse for 27 years; are there any programs to reward our years of service in an inner city environment? I am sure that I am not the only retired parent attempting to repay the Parent PLUS loans.”
You like lists? I like lists. Here's a list of all the reasons not to take out a Parent PLUS loan to pay for your kid's college.
- The kid may become disabled, and you'll be stuck with the bill.
- The kid may not match, and you'll be stuck with the bill.
- The kid may not help you pay it back, and you'll be stuck with the bill.
- You may end up making payments for 25 years only to get an unaffordable tax bill from one of my least favorite creditors.
- The loans won't be eligible for a REPAYE subsidy.
- The loans won't be eligible for PSLF forgiveness.
- The loans won't be eligible for the lower payments available in IBR, PAYE, and REPAYE.
- The forgiveness takes five years longer than in PAYE.
- The child may have some difficulty refinancing the loans into their name (although several of my recommended refinancing companies do this).
- The origination fee is four times as high as other student loans.
- The interest rate is 1% higher.
- It will keep you from reaching your retirement goals.
OK, that's probably enough. You get the picture. These loans suck and should be a last resort kind of scenario. I'd much rather see the student take out private loans and refinance them on the first day of residency than have their parents take out a Parent PLUS loan they'll still have 25 years later.
Working the System
Now, with all that background information, let's see if there is a scenario where a few people could take advantage of a loophole. Imagine you have a parent with a very low income who is already quite elderly. Let's say they were 40 when you were born and you're a non-traditional student who started college at 30. Let's assume they are living just on Social Security. That won't stop the federal government from loaning to a parent. They don't care about your debt-to-income ratio or your credit score. Heck, the student doesn't even need to demonstrate “financial need.” All they care about is your “adverse credit history”:
- A current delinquency of 90 or more days on more than $2,085 in total debt; or
- More than $2,085 in total debt in collections or charged off in the past two years (before the date of the credit report); or
- Default, bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment, or write-off of federal student loan debt in the past five years (before the date of the credit report)
None of that? You're good to go—even if you're 70 years old and living on Social Security.
So, how much can you borrow? Well, it turns out the annual loan limit on a Parent PLUS Loan is the full annual cost of attendance minus other financial aid received by the student. There is no aggregate (cumulative) loan limit. For most people, the Parent PLUS loan comes on top of a maxed-out ($12,500/year for undergraduate) Direct Student Loan each year. Let's say the cost of attendance is $62,500, and you get a direct loan for $12,500. That leaves $50,000 a year in a Parent PLUS loan, so you borrow $200,000 there and the interest clock starts ticking.
Your kid finishes undergraduate (you're now 75), finishes medical school (you're now 79), your kid does a three-year IM residency and a three-year GI fellowship (you're now 85), and you keel over at 86. The loan is forgiven tax-free. And that whole time you had the loans in hardship deferrals or, at worst, consolidated them into an ICR eligible loan with $0 payments.
I'm not sure anyone intended that loophole to be there, but it certainly is there.
But how many people really fit into that loophole? Well, most kids are not born to 40-year-olds. They're born to 20-to-35-year-olds. And most college students don't enroll at 35; they enroll at 18 or so. The parent is much more likely to be 50 than 75. At 50, you're likely to make 25 years of payments before dying.
Remember that the loans (once consolidated into an ICR eligible loan) are wiped out after 25 years of payments, but that comes with a big tax bomb. How big? Well, let $200,000 ride for 25 years at 7%, and it'll be over $1 million. The tax bill on that may be $350,000 or more, all due in a single year. Meanwhile, most parents of doctors are not impoverished, so the payments on that massive student loan may be quite substantial, even in an ICR program.
Ethical Ramifications
I really don't like student loan plans that require anyone to be in debt for 25 years. There is a lot that can change with loan programs and with people's lives that can screw up such a long-term plan. But there's an additional ethical dilemma here—is it really right to borrow money that you have no intention of ever paying back, even if it is legal to do so? And don't tell me it's just like PSLF. With PSLF, there is a requirement to serve the public in a specific way. So, the taxpayer is usually getting something for their money. It feels to me like this sort of scenario (like IDR forgiveness) is taking advantage of the taxpayers' mercy for people in a desperate situation, even though they are not really in one (at least not one that isn't self-imposed).
There are additional concerns, especially if the parent is making the payments. In essence, the doctor, likely the wealthiest of their siblings, is now receiving an additional inheritance—or at least an early inheritance. How will your siblings feel about that?
The bottom line is that yes, this plan works, but I think going down this route deliberately is unethical. If you choose to go down it anyway, at least have the courtesy to gift your parents enough each year to cover the payments and make it right for your siblings.
What do you think? Are you using this plan? What did your parents do with the Parent PLUS loans they took out for you? Do you think this is unethical? Do you think it will work? Comment below!
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I actually fit the loophole. My father was 40 when I was born (43 when my sister was). I’m a stay at home dead who’s been out of the workforce for years. I have a physician spouse. If I had my father take out the loan (I’d pay him directly because of that moral issue and I don’t like the idea of my parents paying for something we should) would the debt pass to my mother before it’s forgiven? As a married couple do they both have to sign? He’s 11 years her senior. Being both male and 11 years older, we are expect shell outlive him. How does this loan work in this case?
https://studentaid.gov/manage-loans/forgiveness-cancellation/death
What happens to my parent’s PLUS loan if my parent dies or if I die?
Your parent’s PLUS loan will be discharged if your parent dies or if you (the student on whose behalf your parent obtained the loan) die.
https://www.fastweb.com/financial-aid/articles/will-a-parent-plus-loan-be-denied-when-applying-for-two-loans-for-two-children
Only one parent can be listed as a borrower on a single Parent PLUS
loan. However, two parents can each apply for separate Parent PLUS
loans for a single child, so long as the combined loan amounts do not
exceed the annual limit. The annual PLUS loan limit is equal to the
cost of attendance minus other aid received. When there are two
children in college, it is also possible for one parent to apply as
the borrower on a Parent PLUS loan for one child and the other parent
to apply as the borrower on a Parent PLUS loan for the other child.
When both parents are applying for Parent PLUS loans, it is possible
that one loan will be approved and the other loan will be denied if
one parent has good credit and the other has an adverse credit
history. Approval does not depend on the number of Parent PLUS loans,
but rather on the credit history of each borrower.
Really interesting post. Everyone’s situation is different and I can’t pretend to understand them all but I do lean towards agreeing with you about these loans.
I took out loans for every penny of my undergrad and med school education. They now total over $400k. They’re obviously a burden on me but I would much rather that be the case than for them to be a burden on my parents as they age. Now I’ve got a plan to repay them aggressively in 5 years.
I also think that having the loans in my name has served as constant motivation (whether needed or not can be debated). This could potentially be lessened if they weren’t in my name 🤷♂️
Ethics, ethics- paying 11% year one then 7% annually in today’s interest rates of <1% on savings and <5% car loans would certainly make many feel they'd already paid their dues so to speak. What we really need (say I, a socialist to some of our readers no doubt) is financial aid that kicks in when a family and student truly would otherwise need parental loans like this to attend school. And better tax treatment if not forgiveness of parental and personal student loans for certain students, more broadly and easily than current public service loan forgiveness.
As someone who started dental school at 26, I didn’t think a parent plus loan was an option. It was during undergrad, but definitely not dental school from what I remember. Direct unsubsidized and grad plus were the only options. But your premise makes sense for expensive undergrads.
You’re right that “plus loans” are just given directly to grad/professional students, rather than to their parents.
I’ll adjust the example in the post
My parents used Parent Plus loans to pay for undergrad for myself + 2 siblings. We each borrowed the limit in federal loans and the Parent Plus loans filled the difference (all went to in state flagship university but I still had ~60K in total loans for 4 years). From day 1, we understood the loans were in my parents’ names but that we kids each owed the money. Fast forward years and we each paid off our portion in a timely manner. Not for one second did we expect our parents to pay this…because they didn’t have the money and needed to prioritize their own expenses/retirement. Obviously, there was risk involved that one or more of us wouldn’t fulfill the agreement but that didn’t happen. I actually paid off the rest of my younger sibling’s portion and had them pay me instead, just to get rid of my parents’ liability faster.
For kids who are poor but not poor enough to get lots of financial aid, this is one of the few options. But I firmly believe this should be kid’s responsibility unless parents are in a position to help without hurting themselves.
Pretty cool that your parents raised such great kids.
Just thought of a sweet, sweet loophole… If mom or dad have ALS or pancreatic cancer you are set. Just get signed up before they make you miss out on this golden opportunity (sarcasm font off).
I had the same consideration for taking out current loans for my daughter’s engineering school when I have more than enough money in a 529– considering they keep talking about 50k of loan ‘forgiveness’. If the gubment is going to give free money then apparently I am the sucker for saving. Incentives matter
I am in this unfortunate situation where my I had to take out this loan with my parents due to not being able to cover the difference. My parents made enough to where I didn’t qualify for federal loans, but I was 1 out of 6 siblings. I went to a state school where I had a scholarship and a job to limit costs.
I have assured my parents that I will be paying these loans off as my first priority, and I have already accounted for them in my “first 12 paychecks as an attending” plan like you preach to create (Thank you for all of this info!). However, I was wondering if as a 4th year medical student, or if I wait 5 months until I am an EM resident, should I try to refinance these loans with a private company to get a better interest rate compared to the 7% I will be sitting at? Also can I even refinance these loans into my name to help my parents, or do my parents have to keep bearing this burden. I hate that I took them out in the first place…
Parent Plus loans are at 0% through September 30th. So no, I wouldn’t refinance them prior to that time. But if your plan is to pay them off eventually, you could refinance them as an intern, yes.
Thank you, I just wasn’t sure if I could do this in order to get the loans into my name to take my parents off of it! I definitely plan on doing it at a later date.
Also I’m sorry, when I was typing this I forgot for about the September 30th date. I don’t plan to do anything until then, and will continue to see how they manage this continued 0% interest.
Thank you for all of the financial help!!
Sad Grad Loan Story- Friends of my parents took out a parent grad loan (non-medical) for their daughter with the understanding that she would pay it off when gainfully employed. Fast forward a decade and she is bringing in around 100k per year plus salary from a working spouse , but refuses to pay towards the loans. To make matters worse, the daughter and her family have essentially cut any ties with the parents despite their attempts at reconciliation (which i’d assume is multi factorial). Won’t even let them visit the grandchildren. All the while, they pay monthly on that loan.
That stuff happens. One reason I don’t like parents doing the borrowing.
Parent PLUS Loans use simple interest. $200,000 @ 7% = $14,000 x 25 years is $350,000 in outstanding interest. It doesn’t capitalize, in the example above, until forgiveness. The taxable income at forgiveness would be $550,000.