Plus loans vs home equity/mortgage loans

calmom
Sat, 24 Apr 2010 18:28:49 +0000

My feeling with debt is to look at a lot more than interest rate.

I have taken PLUS loans and I have always looked at it as a matter of “how much can I afford in a monthly payment”. My plan every year was to balance the cost I paid up front for college with the PLUS loans - figuring that for the coming year I need to pay out $X, and then doing rough math to figure out how to allocate that between debt and up-front payment.

In other words if I can pay, $1000 paid per month = $12,000 for the year – if I need to pay $20K to the college, and $20K gives me a $250/month loan payment - $250 x 12 = $3000 total in payments – but I already figure out hat I could manage more – so if I look at the cost differential, then decide to pay $9000 up front and only borrow $11K, now my loan payment drops to $130 - or $1560 for the year – still leaving me roughly $500 shy of that $12K total expenditure.

For me, it usually ended up making sense to pay about half up front and borrow the other half.

The other part of the equation is that at the end of 4 years, I no longer have to pay the “half” for the tuition expenses – which means that I can afford to accelerate payments on the outstanding PLUS loans. So lets say that 4 years have gone by and I managed to pay out $10K each year up front, borrowing $10K each year, with monthly loan payments of $480 in the final year. In year 5, as I no longer have to pay tuition – I’ve got more cash available to supplement that payment (remember, the hypothetical above assumes I can afford $1000 monthly – in my real life situation its actually significantly less, but I wanted to work with round numbers for purposes of discussion). Let’s say that I simply decide to pay $650 a month rather than the $480 due on my loans – that’s going to leave me a lot of flexibility, but it will also substantially accelerate the pay down of the loans, and of course significantly reduce the overall costs in interest.

I opted for PLUS loans because of the flexibility - my reasoning was that I could always pay off PLUS loans with a home equity loan, but I couldn’t go the other direction. I could plan for the PLUS loan on an annual basis, looking at current needs rather than projecting out for 4 years-- a good choice particularly because my older kid dropped out of his expensive private school after the 2nd year.

I do think that the interest rates on PLUS loans is kind of high. It’s an accident of history – when my son was in college, the PLUS was adjustable and was pretty low. Then interest rates started rising, and about the time the adjustable on the PLUS (based on t-note rates) was about to hit 8%, Congress came in with the fixed interest – clearly with the idea of protecting everyone from rising rates in the future. However… after that time, interest rates began to fall again – so what has happened for me is that I am paying roughly 3% on the PLUS loan I took out for my son, and fixed rates on the PLUS loans I took out later for my daughter. In fact, I could have easily paid off my son’s PLUS loan years ago, but I opted not to simply because it made no sense to pay of a 3% loan only to re-borrow the same money at 8%. (Better to conserve resources and borrow less for my daughter).

Again, you need to look at the big picture with all the variables thrown in. One thing I know is that if I ever lose my job and fall behind on the PLUS loan payments… I won’t lose my home. (And PLUS loans have a number of options for renegotiating payments in the event of hardship).