For many families, PLUS loans are an important source of borrowing to pay for expenses not covered by a Stafford loan. With basically no limit—parents can take out an amount equal to the cost of attendance minus any aid received—and a fixed interest rate of 7.9 percent or 8.5 percent depending on the program borrowed through, PLUS loans are almost always a better option than private student loans, which carry high variable rates.

But for loan companies participating in the Federal Family Education Loan (FFEL) Program, PLUS loans represent a direct challenge to their more profitable private loan offerings. This is a significant conflict of interest given that lenders have authority to approve or deny PLUS loan applications and set some of the criteria they use to make that determination. And data suggests that they may be using this power to help their private loan volume.

Unlike Stafford loans, which have no credit check requirements, PLUS loans can be denied based upon an “adverse credit history.” According to regulations, this simply means that the applicant does not have any outstanding delinquencies of greater than 90 days at the time of applying for the loan and has not have a record of default, bankruptcy, a tax lien, or other similar action in the past five years. The lender, however, may implement stricter criteria if it wishes.

According to Mark Kantrowitz at FinAid.org, lenders in the FFEL Program appear to be using stricter criteria to judge PLUS applicants, leading to a denial rate that is significantly higher than those applying for PLUS loans through the government run Direct Loan Program. Using data from the National Postsecondary Student Aid Study, Kantrowtiz found that in 2007-08, FFEL lenders denied 42 percent of PLUS loan applications. By contrast, direct loan PLUS applicants received a denial just 21 percent of the time. The 2003-04 study showed similar denial rates of 42 percent for FFEL and 26 percent for direct lending.

Why would a lender choose to deny so many PLUS borrowers when the loan carries a 97 percent guarantee against default? One reason might be that PLUS loans are not as profitable than private loans. Though they lack a government guarantee, private loans are almost impossible to discharge in bankruptcy, meaning that the lender can continue to assess penalty fees and interest rates with the understanding that the borrower will be required to pay something.

A lender also receives significantly greater interest payments from a private loan than it does for a PLUS loan. Whereas a lender keeps any money it collects on a private loan, quarterly subsidies for PLUS loans are capped at a rate equal to 3-month commercial paper plus 1.79 percentage points—an amount that lately has been well below the 8.5 percent interest rate charged to borrowers. In the latest quarter, for example, the 3-month commercial paper rate was just 0.41 percent—meaning the total PLUS subsidy rate was just 2.2 percent.

With these financial considerations, it’s understandable why lenders would adopt stricter criteria so they could deny a PLUS loan and increase the likelihood of a borrower taking out a more profitable private loan.* The net result is that what should be a safe borrowing opportunity for families can instead become the gateway to more dangerous debt.

[h/t Tim Ranzetta at Student Lending Analytics]

*Two quick caveats. Borrowers who are denied a PLUS loan do become eligible for greater Stafford loan eligibility, but this added amount is only equal to double the normal Stafford limit. Some borrowers may still need additional assistance, which would then come from the private loan market. Second, it’s unclear how many students are aware for the increased Stafford loan limits and there is no requirement that lenders inform them of that option.