Are you thinking about signing your name on the dotted line and becoming a cosigner? Maybe your son, daughter, or grandchildren are asking you to take on the role so that they can get adequate financing to further their education.
Although it can be tempting to become a cosigner, there are certain dangers and risks you need to know beforehand. Without proper knowledge of the dangers and risks involved, you may find yourself suffering both financially and emotionally years down the line. We regularly deal with cosigners who are confronted with the downside of assuming financial responsibility for private student loans, and are having to evaluate the options of settlement, repayment, or possibly even legal representation.
Private student loan lenders are all too eager to get parents or relatives to become cosigners, without dwelling on the possible negative consequences. Only private student loans can be cosigned, although there is a federal loan program available to parent borrowers called the Parent Plus program. Parent Plus loans are in the parent borrowers’ name only, and are not cosigned in the traditional sense of the term. This article focuses on the issues facing private student loan cosigners.
What’s the purpose of a cosigner?
Before you can fully understand and comprehend your role as a cosigner, you must come to terms with exactly what the role entails. To put it simply, a cosigner is required because without one the student would be unable to qualify for a private student loan – meaning they wouldn’t be able to start or continue their post secondary education. This is due to either a lack of credit history, income, or both. Due to their inability to take out loans, most students will turn to their parents or grandparents to assume the role of the cosigner.
How does this work?
By cosigning a loan, the cosigner becomes responsible for the loan, allowing the student to receive financing they previously wouldn’t be able to get access to.
Sounds pretty good, right?
In theory it sounds like a great way for you to help your loved ones, but there are a lot of dangers involved.
You should also keep in mind that not everyone can presume the role of a cosigner – to qualify the cosigner must be a U.S. citizen or permanent resident, have a social security number, and have good credit and usually good income too.
If you meet all these requirements and you’re debating whether you should take on the role of a cosigner – it’s important you recognize the pros and cons of doing so.
What are the pros of being a co-signer?
The number one reason why parents, grandparents, or relatives assume the role of a cosigner is because by doing so they provide the student with the ability to start or continue their college or post graduate education. Another additional benefit is the student usually gets access to lower interest rates – this makes perfect sense since it’s less of a credit risk for the lender if the loan comes with a cosigner.
What are the cons of being a co-signer?
Aside from the pros, there are some serious cons – the most important of which are:
It you cosign a loan, your credit score can take a ding, meaning it can be difficult for you to obtain other forms of credit down the line. Your Debt To Income (DTI) and Debt To Credit (DTC) ratios will both increase when the new accounts are placed on your credit report. Whether you want to purchase a home or a car in the future, you may not be able to get access to the credit you need. If the student fails to make on time payments or defaults on his/her loan, your credit score will be even more severely impacted. The impact of credit damage to a cosigner is also one of the most common obstacles that we see for borrowers who are considering a strategic default to settle private student loans. The borrower may be okay with sacrificing their credit score in order to get a large reduction through settlement; but the situation becomes more complicated when they have one or more cosigners who will also experience the credit damage that comes with a strategic default.
The cosigner assumes 100% responsibility – by signing, the cosigner assumes equal responsibility for paying back the loan, meaning if the student cannot come up with the funds to pay back the loan, then the private loan lender will come after the cosigner. When considering litigation after a loan has defaulted, many private lenders will focus on the cosigner because they have more income or assets, or access to additional credit lines that could be used to pay the loan.
Now that you’re aware of the general pros and cons associated with being a cosigner, it’s time to explore the must know facts for student loan cosigners.
What are the 6 must know facts for student loan cosigners?
It’s unlikely for students to qualify for a private student loan without someone presuming the role of a cosigner:
Let’s face it – the majority of students do not have great credit histories yet, meaning they’re unlikely to qualify for private loans on their own.
For example, 94% of the private loans taken out in 2015 needed a cosigner. What this ultimately means is that only a small number of students have the necessary credit profiles and income to qualify for a private student loan without a cosigner.
Cosigners are held responsible for the loan:
Parents or relatives choosing to cosign a loan are ultimately assuming responsibility of the loan, so if the borrower fails to make payments; the cosigners’ credit score and history will be negatively impacted.
To make matters worse, if the student is unable to pay back the debt, the cosigner will have to take over and repay the debt. Even if the student dies, cosigners are on the hook for the remaining debt.
But can’t you get a cosigner release? Despite what the institutions may claim it can be extremely difficult to obtain a cosigner release, even after the student is successfully meeting the terms and requirements set forth by the loan.
Limits on federal loans is the predominant reason for co-signed loans:
The federal student loan program should be exhausted first before private loans are considered, but especially for expensive or out of state schools; borrowers can quickly run up against the limits for taking out federal loans and find themselves needing additional funding.
One of the perks of a cosigned loan is lower interest rates:
Being a cosigner does come with some benefits (mostly for the borrower), in the form of lower interest rates. A cosigned loan will almost always offer a better interest rate for the borrower than a loan without a cosigner – if the borrower can even get approved for a loan without a cosigner in the first place.
Cosigner release isn’t exactly what it seems:
Cosigner release programs are quite popular with many lenders and are prominently featured in marketing programs for private student loan lenders– they allow the cosigner to be released from the loan once the borrower meets the lender’s credit criteria, which usually means making anywhere from 12-48 on-time payments consecutively, in addition to sporting a hefty income and well developed credit profile.
If you’re thinking you can get out of a loan by opting for the cosigner release program, you maybe in for a surprise though. Many people have made the mistake of taking on a loan as a cosigner, only to get rejected once they opted for the cosigner release program.
For example, the Consumer Financial Protection Bureau (CFPB) discovered that 90% of cosigners were rejected when requesting cosigner release. Why is this happening?
The obvious answer is lenders like the benefits and additional security from having a co-signer so they’ll make it rather difficult for you to opt out.
For example, far too often the terms of a co-signer release are unknown or buried in the fine print, which is easily glossed over during the initial signing of the loan. Many studies have shown that consumers are unaware of what they have to do to successfully fulfill the requirement for a cosigner release – meaning more and more cosigners are left on the hook for the life span of the loan. Even when they are aware of the requirements, they are often too onerous for the average graduate to fulfill. Even having one missed payment can prevent a cosigner release, for example; and students who prepaid their loans and were classified as having good standing were still rejected for cosigner release. More and more reports are drawing attention to the inefficient cosigner release process, but it remains a major issue within the private student loan industry.
There is a risk for auto-defaults:
An auto-default can happen when either the cosigner or original borrower passes away. Many private student loan lenders are allowed to make claims against a cosigners estate following an aut0-default. We recently negotiated a settlement for a borrower facing an estate claim against their cosigner who had passed away, and it was an extremely difficult negotiation.
To cosign or not to cosign?
It’s apparent that parents, relatives, and grandparents have great intentions when they cosign a student loan, although there are serious repercussions and implications.
It’s best to sit with the student and discuss the path thoroughly if you’re going to go ahead with your cosigning plans, but we recommend first exhausting all options within the federal loan system, and then trying to qualify for private loans on your own before considering a cosigner.
If you’re not in a position to pay back the loan yourself, adding a cosigner will probably just bring about additional financial and emotional hardships down the road.
The bottom line is there is no straight forward answer – you must weigh the risks and benefits with your unique circumstances, before deciding whether or not co-signing makes sense for you and your family. However, cosigning should be a last resort and other avenues to fund the borrowers’ education should be explored first.
To learn more about private loans, co-signers, strategic defaults, and private loan settlement, check out the rest of my blog here.