The Student Loan Rule Change That Could Hurt Parents With Bad Credit

A popular criticism of federal student loans is that they are too easy to get. Borrowers can take on large amounts of debt with little or no indication they can pay it back. The Department of Education has announced new regulations that are aimed at one type of federal loan that does require a credit check — Parent PLUS Loans. But do they go far enough?

PLUS loans are available to parents to help provide financing for children who do not qualify for enough aid on their own. But there are no specific limits on the amount that can be borrowed under this program (other than that parents cannot borrow more than the total cost of their child’s education after other financial aid has been deducted). One parent, for example, recently shared on the Credit.com blog how he has $45,000 in outstanding parent loans but only makes $28,000 a year. His children are unable to help him repay them, and he wrote, “seems like the only way out is through the grave.”

In the final regulations issued by the Department of Education, which go into effect March 29, borrowers who have an “adverse credit history,” may find it harder to qualify. The evaluation will take into account whether the borrower has:

One or more debts that are 90 days or more delinquent with a total outstanding balance larger than $2,085 (when the credit report is reviewed).
Accounts placed for collection or charged off in the two years before the credit report is pulled.
Bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment, or write-off of a federal student loan debt in the past five years.

If any of these conditions exist, a parent borrower isn’t necessarily out of luck. They may be able to demonstrate extenuating circumstances, or get a co-signer. If they do, they must complete PLUS loan counseling before they can get a loan. (Of course getting a co-signer means putting another person’s financial future at risk since they, too, will be completely responsible for repayment of the loan should the primary borrower be unable to pay it.)

A lack of credit history does not equal an adverse credit history, so those who have not established credit won’t be disqualified.

“PLUS loans can be dangerous products, with higher interest rates than other federal student loans and fewer flexible repayment options,” say Persis Yu, staff attorney with the National Consumer Law Center, which recently critiqued the new credit check rules. “Federal loans generally have very draconian consequences for borrowers who default such as garnishment of wages, Social Security benefits, and tax refunds,” she said in an email. “Therefore, we were hoping that the Department would implement some kind of ability to repay standard to ensure that borrowers who get these loans are able to afford them.“

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As with all student loans, it can be very difficult to discharge these in bankruptcy.

“Since PLUS loans are issued to ‘close the gap’ between the normal federal direct loans and the cost of attendance, I think changes like these make people look harder at the true debt burden and potential payback they are getting for that risk,” says Pete Wylie, co-founder of Gradible, a website that helps students manage and pay off their student loans. “That’s a good, and needed thing in the student loan industry.”

These changes mean that parents thinking about borrowing to help their children finance their college educations would be wise to review their free annual credit reports to see if they contain any of the adverse items listed above that could affect their ability to borrow. And while a specific credit score won’t be one of the criteria required to get a PLUS loan, it is still good idea to review your credit scores to see where you stand. (You can get two of your credit scores for free every month on Credit.com.)

And think twice about whether one of these loans is the best option in the long run. If you are counting on your child to help with the payments, what happens if they can’t? What if your income is interrupted or you have other expenses that make it difficult to make the payments? “There are too many other routes for financing that are less potentially damaging to future credit profiles of both the recipient and co-signer,” says Wylie.