Parental Borrowing for College Comes with Repayment Issues

By Wenhua Di, Carla Fletcher and Jeff Webster

ollege is an investment that gener- standing federal education .3 The ally yields benefits over a student’s approximately 3.5 million parent PLUS } C lifetime in the form of higher borrowers (8.2 percent of all federal ed- wages, more stable employment and ucation borrowers) were respon- ABSTRACT: As the cost of better benefits. Typically, parents want sible for $87.7 billion, or 6.2 percent of college continues to rise, to help their children with college costs, the outstanding loan debt. but they don’t always have enough sav- Stafford loans (named after former parents are increasingly ings to do so. Vermont Sen. Robert Stafford) are taking out federally backed Since the 1950s, federal government based on the level of financial need loans to help make ends student loan programs have encour- calculated using data supplied by meet for their children. aged postsecondary education. More students through the Free Application recently, federal assistance for parents for Federal Student Aid.4 Stafford loans, Parents, while often wanting to help their children with available to borrowers regardless of more adept at managing college costs came in the form of the credit score, usually carry lower inter- debt, assume some of federal Parent Loan for Undergradu- est rates than private loans. They also the financial risks of their ate Students (PLUS) program. It was offer various borrower protections such created in 1980 and assists parents who as hardship deferments, forbearance, offspring who are seeking are borrowing for their offspring’s col- income-driven repayment options and higher education. lege expenses. public service loan forgiveness. Parents have increasingly taken out Stafford loans have annual and ag- PLUS loans, with the average amounts gregate borrowing limits. With rising borrowed growing.1 The parent loan college prices and high financial need default rate remains low, though signs among students from middle- and of it increasing have appeared.2 lower-income families, there are often Parents’ repayment behavior differs substantial gaps students must fill from that of students, with parent bor- through savings, paid work and contri- rowers presenting their own benefits butions from family and friends. and risks. Parent borrowers tend to PLUS loans carry higher interest have more experience dealing with rates than Stafford loans and are in- debt and more realistic expectations tended for families who have exhaust- for repayment than students. At the ed student borrowing options.5 PLUS same time, parents say taking on loans borrowing limits were modified in 1992 for their children may affect their abil- to offer greater flexibility. Parents were ity to save for retirement and undertake subsequently allowed to borrow up to major purchases. the difference between the total and the amount of other PLUS Program Growth financial aid, regardless of expected Most federal education loans are family contribution, as long as the loans to students. Stafford loans make parental borrowers did not have an up the largest portion of the borrowing. adverse credit history.6 This modifica- As of second quarter 2018, there were tion typically provided parents with the 29.5 million subsidized Stafford loan ability to borrow much larger amounts. recipients (receiving relatively favor- Although PLUS borrowers are fully able terms) and 28.3 million unsubsi- responsible for loan repayment, many dized recipients, together representing proceed because they have altruistic $753 billion of the $1.4 trillion out- motives.7 College education typically

14 Southwest Economy • Federal Reserve Bank of Dallas • Third Quarter 2018 CHART 1 Parents' Share of Undergraduate Federal Loan Programs Increases

Billions of dollars 120

100 Subsidized Unsubsidized PLUS 80

60

40

20

0 10–’11 11–’12 12–’13 13–’14 14–’15 15–’16 16–’17 00–’01 01–’02 09–’10 98–’99 96–’97 97–’98 99–’00 02–’03 04–’05 06–’07 ’ ’ ’ ’ ’ ’ ’ ’ ’ ’ ’ ’0 3–’04 ’0 5–’06 ’0 7–’08 ’0 8–’09 ’ ’ ’ ’ ’ ’

NOTE: Each time period refers to a school year. SOURCE: College Board, Trends in Student Aid 2017. leads to a host of financial and other Deteriorating Loan Repayment The U.S. Department of Education lifetime benefits.8 There could be some Parents can potentially access either has published default rates for PLUS net gains for parents as well. Parents’ a federal PLUS loan or a private loan. loans for fiscal 2006 to 2010 Table( 1).11 net lifetime income may increase as However, parents with lower credit The overall default rate increased from a result of incurring PLUS debt—if a scores can’t easily obtain a private 1.8 percent in fiscal 2006 to 5.1 per- child completes a college degree, the loan, which involves more rigorous cent in fiscal 2010. The rate more than subsequent higher income may offset underwriting. So, while PLUS loans are doubled for loans involving students the need for other future support from not need-based and were designed to enrolled in proprietary, private non- parents and allow contributions from support education for families of any profit and public institutions during children to parents in old age. income level, they tend to attract lower- the period, with the rate at proprietary income borrowers and those who can’t institutions being the highest.12 Greater Parental Borrowing qualify for private-lender funding. In response, the Department of PLUS loans comprise an increasing This “adverse selection” of borrowers Education tightened the parent PLUS proportion of federal aid to students into the PLUS program became more credit check rules in October 2011. and their families. About 8.6 percent apparent when conventional under- Loan denials increased 10 percentage of the $42.1 billion (in 2016 dollars) writing tightened following the Great points the following year.13 The denial in undergraduate loans originated in Recession.10 rate is also linked to a steep enrollment the 1996–97 academic year were PLUS loans (Chart 1). The share rose to 15 percent of $84.2 billion in the 2016–17 TABLE academic year. The $15,878 average Parent PLUS Loan Defaults Increase Throughout Recession parent loan was $6,251 more than two 1 decades earlier—much greater borrow- Fiscal year Fiscal year Fiscal year Fiscal year Fiscal year Three-Year Cohort Default Rates ing than the average amount of Stafford 2006 2007 2008 2009 2010 9 subsidized or unsubsidized loans. Parent PLUS overall (%) 1. 8 2.2 2.6 3.4 5.1 Like other federal education loans, Parent PLUS proprietary (%) 4.7 5.5 6.3 8.3 13.3 PLUS loans are usually nondischarge- Parent PLUS private nonprofit (%) 1. 2 1. 6 2.0 2.5 3.4 able in bankruptcy. Borrowers may Parent PLUS public (%) 1. 2 1. 6 1. 9 2.2 3.1 also have their wages, tax refund and Social Security benefits garnished if NOTE: Rates are calculated based on borrowers entering repayment after in-school deferment. Proprietary institutions they default on the loans. are generally for-profit private schools. SOURCE: U.S. Department of Education, 2012.

Southwest Economy • Federal Reserve Bank of Dallas • Third Quarter 2018 15 TABLE Loan Characteristics and Education Experience rowers defaulted during the seven-year period. Those who defaulted obtained by Parent PLUS Loan Default Status* 2 fewer loans with smaller beginning Variables Borrowers not in Borrowers in balances, paid down less of the balance default default and had higher levels of delinquency, PLUS Loan Characteristics deferment and forbearance than those Avg. number of PLUS loans per borrower 2.0 1. 5 not in default (Table 2). Highest interest among PLUS borrowings (%) 7. 4 7. 2 Parents who defaulted mostly sup- PLUS loan beginning balance ($) 19,509 12,403 ported students who took more time attending school.16 Relative to borrow- PLUS Loan Performance ers not in default, the children of those PLUS loan amount paid down ($) 8,080 109 in arrears were more likely to enroll in a Delinquency (%) 26.4 96.3 two-year public college, a for-profit pro- Deferment (%) 13.2 16.0 prietary (private) school or a minority- serving institution and less likely to Forbearance (%) 31.8 56.5 attend a four-year public or nonprofit Student Borrowing, Enrollment and private college and to have graduated.17 Education Attainment Multivariate statistical models—a Children’s Stafford loan amount ($) 18,831 17,015 means of examining the interplay Second year funded by PLUS loan (%) 19.3 20.2 between several variables and an Third year funded by PLUS loan (%) 1 7. 8 13.5 outcome—were developed to examine Fourth year funded by PLUS loan (%) 24.6 12.6 how some of these factors explain the 18 Fifth year funded by PLUS loan (%) 1. 5 0.7 likelihood of a PLUS default. Hold- Two-year public (%) 3.7 5.0 ing other factors constant, PLUS loans are more likely to default if the stu- Four-year public (%) 64.4 57.5 dents also borrow large amounts, have Four-year private (%) 22.4 20.1 dropped out of college without a degree Proprietary (%) 5.0 14.8 or enroll in a four-year private, propri- Minority-serving institution (%) 30.2 44.0 etary or minority-serving institution. Graduated (%) 48.8 36.8 On the other hand, PLUS borrowers Withdrawn (%) 25.1 37.1 are less likely to default if they enter repayment with a higher beginning bal- *Based on borrowers entering repayment in fiscal 2005–10. ance or fund children who have already NOTE: Loans from Trellis Co. portfolio, shown in nominal dollars. completed relatively more schooling, SOURCES: Trellis Co.; authors’ calculations. are enrolled part time or have gradu- ated from college. Parents’ default decline in 2011 among historically ally lower (albeit rising) default rate. probability is much more related to black colleges and universities, which Trends, patterns and the experiences of their children’s college experience than tend to be low-resourced schools with parental borrowing emerge in adminis- to the PLUS loan’s characteristics. limited institutional grant funds to trative data of PLUS borrowers as- A students' college experience may support their disproportionately large sembled by the Trellis Co., a nonprofit be tied to family finances, academic economically disadvantaged student student loan guarantor that has helped aspirations and borrower risk prefer- populations.14 administer the Federal Family Educa- ences, all of which can influence repay- With the policy change, many tion Loan Program in Texas since 1979. ment behavior. parents who relied on the PLUS loans The dataset covers 62,449 parent were shut out. Officials later loosened PLUS recipients who entered repay- Outperforming Stafford Loans the standard to allow greater participa- ment between October 2004 and Sep- The Trellis data also include infor- tion. Still, families with large unmet tember 2010, with children attending mation on Stafford loans, allowing need using PLUS are the most likely to Texas institutions. review of overlapping parent PLUS struggle with repayment.15 Trellis’ data track borrowers’ repay- and student Stafford loan data from ment behavior from the beginning of September 2006 to August 2009. Loan Outcomes Examined repayment and continuing for the next Compared with Stafford borrowers, Studies of PLUS loans have been seven years or until the loans were PLUS borrowers on average took out limited, largely because of the rela- paid in full, consolidated and changed fewer loans, had higher initial balances tively small share of PLUS loans in the guarantor, or the borrower defaulted. and paid a higher interest rate. PLUS student loan market and the gener- About 8.6 percent of these PLUS bor- borrowers’ children were more likely

16 Southwest Economy • Federal Reserve Bank of Dallas • Third Quarter 2018 to attend four-year public or private in- CHART PLUS Loans Outperform Stafford Loans Seven Years stitutions instead of a two-year public After Repayment Begins institution or proprietary college, had 2 a higher graduation rate, were more In repayment or paid off In default Consolidated likely to enroll full time and much less likely to drop out. Since parents are generally older, Stafford financially more stable and more expe- rienced with debt, it is not surprising that PLUS loans have better repayment outcomes than Stafford loans (Chart 2). For borrowers seven years into repay- PLUS ment in the Trellis portfolio, the default rate on Stafford loans was 28.3 percent, 18.1 percentage points higher than that 0 20 40 60 80 100 of PLUS loans. Percent Despite a default rate increase around the recession, PLUS loans have SOURCE: Authors’ calculation based on Trellis data for fiscal 2007, 2008 and 2009. been the only federal student loan program that generates profits for the government and, thus, helps offset collegiate pathway to adulthood, when 6 Parents need to pass the PLUS loan credit check. other federal educational loan program parental borrowing is involved, seems See, “Direct PLUS Loans and Adverse Credit,” U.S. costs. PLUS loans are forecast to gener- to come with parental sacrifice as well Department of Education, March 2015, https:// ate a $20.6 billion profit for the federal as a transfer of financial responsibility. studentaid.ed.gov/sa/sites/default/files/plus-adverse- government from 2018 to 2028.19 credit.pdf. PLUS loans also outperform Staf- Di is a senior economist in the Research 7 See “Borrowing Constraints, Parental Altruism and ford loans after controlling for other Department at the Federal Reserve Bank Welfare,” by Jorge Soares, Journal of Macroeconomics, factors.20 Student borrowers are more of Dallas. Fletcher is a senior research vol. 45, 2015, pp. 1–20. likely to default if they attend a two-year analyst and Webster is the director of 8 “America's Divided Recovery: College Haves and Have- public institution, enroll part time or research at Trellis Co., a Round Rock, Nots,” by Anthony P. Carnevale, Tamara Jayasundera withdraw without a degree. Attending Texas, nonprofit corporation that seeks and Artem Gulish, Georgetown University Center on a nonprofit, private four-year institu- to help students retire education loans Education and the Workforce, June 2016. tion tends to to increase the chance of and improve access and outcomes 9 All calculations are in 2016 dollars. PLUS loans totaled default for parent borrowers but not involving education. $12.6 billion in 2016–17. Data are from “Trends in for students. Student Aid 2017,” College Board, accessed July 20, Notes 2018, https://trends.collegeboard.org/student-aid. Parent, Student Interviews 1 Parents may also borrow from private lenders with 10 Some families prefer PLUS loans because of the To learn more about PLUS expecta- terms, conditions and interest rates set by the lender repayment flexibility federal loans offer. PLUS borrowers tions and experiences, 49 parent bor- based on the borrower’s creditworthiness. Graduate can consolidate their loans and join the Income- rowers and 36 students whose parents students can obtain loans for themselves under a Contingent Repayment Plan, which is less generous than had borrowed on their behalf were separate program, also called PLUS. That program is not most other income-driven repayment plans but caps interviewed. Parent borrowers tended the focus of this article. payments at a share of earnings. to have more experience dealing with 2 The PLUS loan default rate increased around the 11 A cohort default rate, the standard measure of debt and had more realistic expecta- recession. Recent official data are unavailable. federal education loan performance, is the percentage tions for repayment than did students. 3 Federal Student Loan Portfolio, U.S. Department of of borrowers who enter repayment during a particular Overall, the majority of the parents Education, accessed July 20, 2018, https://studentaid. federal fiscal year, Oct. 1 to Sept. 30, and default or fail and students expected the parents to ed.gov/sa/about/data-center/student/portfolio. to meet other specified conditions prior to the end of the repay the PLUS loans. The decision to 4 Subsidized and unsubsidized loans have the same second following fiscal year. pay for college through PLUS loans interest rate fees. Students who demonstrate financial 12 Proprietary postsecondary institutions refer to those didn’t always follow thoughtful discus- need and qualify for subsidized loans do not have the private, profit-seeking colleges that operate as businesses. sions with students about explicit aca- loan interest accrued while in school or during the 13 “Cracking Down on PLUS Loans,” by Libby A. Nelson, demic expectations and implications of grace period. Inside Higher Ed, Oct. 12, 2012, www.insidehighered. ongoing financial obligations. 5 As of July 1, 2017, the PLUS loan interest rate was com/news/2012/10/12/standards-tightening-federal- Parents also reported that PLUS loans 7.0 percent, and the loan fee at disbursement was 4.26 plus-loans?. affected their ability to save for retire- percent, while Stafford loan interest was 4.45 percent and ment and make major purchases. The the loan fee 1.07 percent. (Continued on back page)

Southwest Economy • Federal Reserve Bank of Dallas • Third Quarter 2018 17 Parental Borrowing for College Comes with Repayment Issues

(Continued from page 17)

14 Before 2010, federal student loans were either made 15 The U.S. Department of Education sets the minimum historically black colleges and universities in Texas directly by the federal government or by private lenders total debts with adverse conditions (i.e., accounts in include Texas Southern University and Prairie View A&M but federally guaranteed. The guaranteed loan program collection or charge-offs) as exceeding $2,085 (inflation University; the largest Hispanic-serving institutions implemented stricter credit checks on borrowers than the adjusted, 2015 dollars), instead of any amount. Thus, include the University of Texas at San Antonio and the direct loan program. Officials subsequently made all new fewer borrowers are disqualified. University of North Texas at Dallas. student loans direct loans, though underwriting became 16 Some students may take more than four years to 18 A logit model and a proportional hazard model are stricter. PLUS default rates are not factored into an complete a standard four-year program. developed. The results are consistent across econometric institution’s student loan default rate, which determines 17 The minority-serving institutions were defined specifications. the institution’s eligibility for federal aid. See, “The according to the integrated postsecondary education data 19 Authors’ calculation based on “Student Loan Wealth Gap PLUS Debt: How Federal Loans Exacerbate system data, which include historically black colleges Programs—CBO’s April 2018 Baseline,” Congressional Inequality for Black Families,” by Rachel Fishman, New and universities, predominantly black institutions and Budget Office, April 2018, www.cbo.gov/sites/default/ America Foundation, May 2018, https://s3.amazonaws. Hispanic-serving institutions. Some of minority-serving files/recurringdata/51310-2018-04-studentloan.pdf. com/newamericadotorg/documents/Wealth_Gap_Plus_ institutions are eligible for federal Title III funding under 20 As shown in a logit regression of the likelihood to Debt_FINAL.pdf. the Higher Education Act. In Trellis data, the largest default on a loan and borrower characteristics.

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