How PLUS Loans Work

The average sticker price of a private U.S. college education in 2009-2010 was $26,273 a year. At public colleges, the cost averaged $7,020 a year. If those figures don't sound terribly high, remember that college is a four-year deal. You should also note that a whopping 20 percent of college students attend schools where the tuition and fees total more than $36,000 a year [source: College Board].

The good news is that close to 80 percent of full-time undergraduates received some form of financial aid in 2007-2008 [source: NCES]. But even after that student financial aid package comes in the mail, there is usually a balance left to pay. That's where PLUS loans can pick up the slack.

PLUS loans are federally subsidized loans taken out by parents of college students to help pay for their child's undergraduate education. The PLUS loan can be applied to all eligible educational expenses (tuition, room, board, books and supplies) that are not already covered by other financial aid funds like scholarships, federal work-study or loans.

In the 2007-2008 school year, 9.6 percent of parents with dependent undergraduate students received PLUS loans at an average loan amount of $11,400 [source: NCES].

For parents of college students, PLUS loans are more attractive than private bank loans because they have a relatively low, fixed interest rate for the life of the loan. And unlike most private loans, which need to be paid back immediately, PLUS loans don't have to be repaid until the student has graduated or stopped attended school at least half-time. There is no minimum amount for a PLUS loan, but there is a maximum: The total amount of the PLUS loan cannot exceed the total cost of educational expenses minus existing financial aid.

Like any good federal programs, PLUS loans have their share of confusing terminology and bureaucratic red tape. We'll do our best to walk you through the eligibility requirements and application process to help make your college education more affordable.

PLUS Loan Eligibility

PLUS loans are parent loans, not student loans. PLUS loans are designed to give extra financial support to parents who are still covering the majority of their child's living expenses.

To be eligible to receive a PLUS loan, you must be the parent of a student who'll be enrolled at least half-time in a degree program at an eligible undergraduate institution. Eligible schools are part of the Federal Family Education Loan (FFEL) program. That includes most American colleges and universities. Ask your financial aid office if you're not sure.

In addition, the student in question must be listed as your dependent for tax purposes. Stepparents are also eligible, as long as the child is listed as their dependent. The child must live with the parents when he or she is not at school and parents must provide for at least 50 percent of the student's total living expenses.

For divorced parents, only one parent can apply since only one parent can claim the child as a dependent. However, if the custodial parent doesn't qualify because of bad credit, the other parent can sign as an endorser or co-signer [source: Rebello]. Legal guardians cannot apply for PLUS loans.

The same citizenship requirements apply to PLUS loan applicants as the other federal financial aid programs. Both the student and the parent must be U.S. citizens, nationals or eligible non-citizens [source: FinAid].

If you're the parent of a student attending graduate or professional school, you're ineligible for a PLUS loan, but your student is. Graduate PLUS loans carry the same requirements and interest rates as so-called Parent PLUS loans, but they're in the student's name. To qualify for a graduate PLUS loan, a student must have submitted a Free Application for Federal Student Aid (FAFSA) and received all federal financial aid, including Stafford loans. Only then can the student apply for a graduate PLUS loan.

Grad PLUS loans, as they're known, have an advantage over Stafford loans because they're based on credit rather than need. So if you don't qualify for a lot of money in Stafford loans, you can still secure a low-interest student loan if you have a good credit history.

Unfortunately, just because you're eligible for a PLUS loan doesn't mean that you're guaranteed to get one. Keep reading to learn what it takes to qualify for a PLUS loan.

Qualifying for a PLUS Loan

Unlike most other federal financial aid programs, PLUS loans aren't need-based. They're credit-based. To qualify for a PLUS Loan, you don't have to prove financial need; you only have a show a stable and healthy credit history. This is established through a standard credit check.

Your credit history doesn't have to be spotless to qualify for a PLUS Loan. You can have a few late payments and high balances in your past, but you can't have any major boo-boos that would count as adverse credit.

Adverse credit, as defined by the Higher Education Opportunity Act (HEOA) means that one of the following events shows up on your credit report:

You're currently more than 90 days late on a debt payment, including credit card payments, car loans, mortgage payments and other student loans, etc.
In the last five years, you've declared bankruptcy, defaulted on other educational loans, or have been the subject of a foreclosure, repossession or wage garnishment

[source: Oklahoma Guaranteed Student Loan Program].

If you think that your credit history might show some adverse credit, order a credit report before you apply for a PLUS Loan and see if you can negotiate settlements or alternative payment plans with any of your creditors.

If you're denied a PLUS Loan because of bad credit, you still have some options. First, you can find a relative or friend with better credit to endorse the loan. Endorsing is the same as co-signing, which means that the person who endorses the loan is equally responsible for the timely repayment of the loan. If the parent is late or delinquent in repaying the loan, the credit of the endorsing party will also suffer.

Another possibility if you have adverse credit is to provide proof of extenuating circumstances that may have contributed to the lackluster credit history. According to the Ensuring Continued Access to Student Loans Act of 2008 accepts the following extenuating circumstances:

Up to 180 days late on mortgage payments
Up to 180 days late on medical payments

[source: Oklahoma Guaranteed Student Loan Program]

Because PLUS Loans are federal loans, you won't qualify if you or your student are currently in default on another federal student loan, or owe a refund on a federal education grant.

If your credit history is in good shape, then you're good to go. Now let's learn more about the two different kinds of PLUS Loans: direct and FFEL loans.

Direct PLUS Loans vs. FFEL PLUS Loans

Just to make the financial aid process a bit more confusing, there are two PLUS Loan programs. Both are federal loans, but one is handed out directly from the government and the other is serviced by a private lender.

The official name of the direct loan program is the William D. Ford Federal Direct Loan Program, but we'll just call it the Direct PLUS Loan Program. With this loan, you apply directly to the government and the government pays the funds directly to your school.

he other program is called the Federal Family Education Loan (FFEL) program and the loan itself is known as the FFEL PLUS Loan. The major difference is that instead of applying to the government, parents apply to their choice of private lender. The private lender is the one who decides if the parent qualifies and the lender is the one that pays the school. These loans still carry a fixed interest rate and are federally guaranteed.

One major difference between the two loan types is their interest rates. Direct PLUS Loans have a fixed interest rate of 7.9 percent and FFEL loans have an interest rate of 8.5 percent. Another difference is that the FFEL PLUS Loan gives you a choice of lenders, while the Direct PLUS Loan does not.

There is some evidence that FFEL PLUS Loans are harder to qualify for than Direct PLUS Loans. The 2007-08 National Postsecondary Student Aid Study (NPSAS) revealed that 42 percent of FFEL PLUS applicants were denied loans and only 21 percent were denied under the Direct PLUS program. This is because the law allows private lenders to apply "more restrictive standards" [source: FinAid].

Depending on your school, you may not have a choice as to which loan program you apply. Some schools only participate in one program. As of March 2010, the U.S. Department of Education says that 46 percent of colleges accept the Direct PLUS Loan and 39 percent more are transitioning to the program [source: Liberto]. That's a major shift from 2008, when only a quarter of schools participated in the Direct PLUS program [source: FinAid]. Pending legislation could end the FFEL program altogether and bring all federal student loans under the Direct Loan program umbrella [source: Liberto].

Now let's look at the application process for both types of PLUS Loans.

Applying for a PLUS Loan

Like all federal financial aid programs, you have to apply for a new PLUS Loan every year, since financial circumstances and credit scores can change quickly. Whether your school participates in the Direct PLUS Loan or FFEL PLUS Loan program, the application process starts in your school's financial aid office or financial aid Web site.

Once you have completed the PLUS Loan application, you need to sign something called a Master Promissory Note (MNP). The MNP is exactly what it sounds like: a promise to repay the loan in full. You can sign a paper version of the MNP or sign it electronically using the Department of Education PIN you received when you filled out the FAFSA. Whether you are applying for a Direct PLUS or FFEL PLUS Loan, you return the application to your school's financial aid office.

Since we mentioned the FAFSA, it's not technically required as part of the PLUS Loan application process, but many schools ask for it anyway. The good news is that most students apply for federal financial aid before the PLUS Loan, so the FAFSA is usually already completed.

If your school participates in the Direct PLUS program, it will forward the PLUS Loan application to the U.S. Department of Education, and you will be sent either an award letter or a denial. If your school chooses to use the FFEL PLUS program, it will ask you to choose the private lender where your loan will originate. All private lenders must offer the same interest rate (8.5 percent), but there are other criteria that might sway your decision.

Your school likely maintains a list of preferred lenders. Research and compare the offers made by different lenders. Many will offer to waive upfront fees or give other discounts that could save you money. If you want more information about local lenders, contact your state guaranty agency. This is the agency that administers the FFEL program in your state. To locate your state's agency, call 1-800-4-FED-AID (1-800-433-3243).

Now let's look at exactly what you're signing up for with a PLUS Loan.

Terms of a PLUS Loan

If you qualify for a PLUS Loan, the funds will be paid out to the school in two installments. The checks are usually sent directly to the school, but some schools require the parent to endorse them first.

There are rules about how PLUS Loan funds can be used. First, the money is used to pay your remaining tuition, room and board, fees and miscellaneous educational expenses. If any money is left over, it's given back to the parent, who must also use it to cover educational expenses. If the parent chooses, he or she can release the money to the student or hold the extra funds in a school account.

The fixed interest rate for all Direct PLUS Loans is 7.9 percent for and the rate for FFEL PLUS Loans is 8.5 percent. Unlike subsidized federal loans, interest starts accruing the minute the funds are released. However, you don't have to start repaying the loan immediately. You can wait until 60 days after the full amount of the loan has been disbursed; or wait until six months after the student graduates or ceases to be enrolled on a half-time basis [source: Federal Student Aid].

There is also a processing fee associated with each PLUS Loan. Every time the loan is disbursed, the government pulls out four percent to cover its costs. If you receive a FFEL Loan, a portion of that four percent will go to the lender itself.

The specific payment terms for FFEL PLUS Loans vary with each lender, but generally you have 10 years to pay back the loan. To make payments, the parent either sends checks directly to the government (Direct PLUS Loans) or to the private lender who's servicing the loan (FFEL PLUS Loans).

Under certain circumstances, you can apply for deferment or forbearance, which are temporary reprieves from repayment. Under the law, you qualify for deferment if you're unable to find employment or suffer economic hardship (for up to three years). You also qualify if you're enrolled half-time in a college or a graduate fellowship program.

The twist is that you still accrue interest on your loan even if you're not paying it back. Even worse, during deferment the interest is capitalized, or added onto the principal of the loan, increasing the total loan amount [source: Federal Student Aid].

Forbearance is another temporary reprieve. A lender can grant forbearance for any number of reasons, although the borrower will need to provide written proof -- medical bills, unemployment records or death certificates -- to back up those claims. Each period of forbearance can last no longer than 12 months at a time for a total of three years. Like a deferment, interest also continues to add up.

For more information on financial aid, take a look at the links on the next page.