Approximately 90 percent of private student loans had a parent cosign a loan, according to a 2012 report from the Consumer Financial Protection Bureau (CFPB) and U.S. Department of Education. That’s a significant increase from previous years.
Many young adults headed to college aren’t in the position to work with lenders. That’s because they don’t have enough credit history to qualify with private student loan lenders.
Their credit scores usually aren’t high enough, either. And, most students can’t show enough income to prove they can afford to repay what they borrow.
That’s why most parents find themselves signing on the dotted line to help finance education costs. The loan is in the student’s name and they are responsible for paying it off when it’s due. But cosigners still take on a lot of risks.
Before you cosign a loan, here are five questions you should ask as a parent.
1. What happens when I cosign a loan?
When you cosign a loan, you agree to take on the responsibility of repaying the loan should the original borrower default.
You don’t borrow any money yourself. The loan and the amount borrowed will go to your student.
In an ideal scenario, you help your student get the loan. You do not make payments because the student is the borrower and they are primarily responsible.
2. Why should I cosign a loan for my child?
Most private student loan lenders require a cosigner before approving a new loan to a student.
That’s because borrowers must display a strong credit history to qualify for these loans on their own.
Yet, even if a student has a credit history, they may not have had time to build up a good credit score.
Credit scores are largely based on a history of on-time payments made in full. However, credit scores are also based on the average age of each line of credit on your report.
For an 18-year-old on their way to college, they just don’t have enough time to create a good credit score needed to qualify for a loan and secure a good interest rate.
Income is also an issue when signing up for a private student loan.
Most private student loan lenders require borrowers to show they have the income to reasonably afford to repay the loan. College student incomes rarely make the cut.
Parents can help fill these gaps when they cosign a loan. If you have a good credit history, a strong score, and can show you have the income to repay the loan if your student stops making payments.
Parents co-sign loans because it helps their students. And if your student makes their loan payments on time and in full, it may help bump your own credit score.
But the risks tend to outweigh that small reward.
3. What are the risks associated with cosigning for a loan?
Cosigning for a loan allows your child to access a financial product that might otherwise be out of their reach.
However, you do risk ruining your credit and damaging your financial standing.
When you cosign a loan, you agree to take on the responsibility of that debt if your student fails to make payments. That’s a legal obligation. And the lender can come after you and your assets.
It doesn’t matter what the reason is if your child is unable to make student loan payments. You’re responsible if the borrower doesn’t pay.
In addition to having payments put on your plate, your credit score will suffer if you student fails to repay their private student loans.
Even if your child does a great job of managing payments and repaying the debt, cosigning for a loan increases your debt-to-income ratio since the loan appears on your credit report. This could also impact your ability to take out your own loans in the future.
Additionally, your relationship with your child could suffer serious damage if you experience any of these financial consequences. While everyone may enter the agreement with the best of intentions, money issues can tear families apart.
4. What are the risks for my child when I cosign a loan?
When cosigning for a loan, you put your credit and financial status on the line. But helping your student take out a private loan by cosigning may also put them at risk later on down the road.
Many lenders will put private student loans into default if a cosigner passes away. The same is true if the cosigner files bankruptcy.
Auto-default means the lender can require the entire balance of the loan. The borrower’s financial situation or payment history doesn’t matter.
If a loan goes into default it can damage the borrower’s credit. Debt collections can also start if they can’t immediately repay the remaining balance.
Parents can try to prevent these unintended consequences for students. You can go to your lender to request a cosigner release, but that isn’t always easy.
That’s why the CFPB put together a cosigner release resource guide. It helps parents and their children walk through the process of successfully getting a cosigner release on a student loan.
5. What are alternatives to cosigning a loan?
Cosigning for a loan is not the only way to help your student pay for college. As a parent, you can also consider these alternatives for them.
Help your student look for scholarships and grants.
Although the cost of college is on the rise, borrowing money may not be necessary. Look for programs from schools, private institutions, and the government.
You don’t need to repay scholarships or grants. That’s why these are always the best routes to take before getting loans.
Get a federal student loan.
Always fill out and submit an FAFSA before looking into private student loans. This will show you what federal student loans your student can receive.
Federal student loans usually come with lower interest rates and do not require a cosigner.
Create an informal, family loan.
Can you and your student agree that you’ll provide a set amount for school expenses if they’ll pay you back?
This may be a better way to work out college financing than going through a lender, who will charge interest.
You still take a risk that your money won’t be repaid. But it may be a risk you feel more comfortable with than the ones you take on as a cosigner.
Research ways to get a private student loan without a cosigner.
These are actions your student can take to get the loan they need to pay for school on their own.
Should you cosign a loan for your child?
Again, cosigning for a loan on behalf of your student comes with both benefits and risks.
Now that you understand them both, take that knowledge and make the decision that’s best for your family financially.
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