Today I’ve got a guest post by David Chen from Millennial Personal Finance. David writes about a variety of personal finance topics, and today shares about some of the potential consequences of cosigning on student loans.
There is no doubt about it: college is expensive, and the cost is only going up. For many, saving enough to pay for our kids’ college education is next-to-impossible, with a year of tuition for many schools costing more than a luxury SUV. That leaves us looking for scholarships, grants, work-study programs, and loans to pay for college and university for our kids.
Sometimes federal student loans are adequate to pay for college on top of savings and the other items mentioned above. But because federal student loans are somewhat limited, they may not be enough to cover the full cost of college for all your kids. Many students then turn to private student loans to fill the gap in funding. Private student loans can help tremendously, and may even offer similar or lower interest rates than federal student loans. But unlike federal student loans, private student loans are approved exclusively on an applicant’s creditworthiness.
The solution for many borrowers is a cosigner. A cosigner is a person who guarantees a loan, agreeing to pay the loan in the event that the primary borrower — the student — fails to pay it. In most cases, the cosigner is a family member, such as a parent, grandparent, aunt or uncle, although it may also be a trusted friend or other close relative. A cosigner will typically be older and have an established credit history and a high credit score, permitting the lender to take the risk of lending the student money. Having a cosigner typically results in a lower interest rate, as the lender is more confident that the loan will be repaid — but it can be incredibly risky for the cosigner.
When you sign a student loan as a cosigner, you are assuming responsibility for that loan. If the primary borrower misses a payment, then your credit score takes a hit — it is the equivalent of you missing a payment on one of your own debts. If the primary borrower goes into default on the loan, then you will become responsible for the loan. The loan may even be accelerated and immediately due if it goes into default, making you immediately liable for the full amount. This may even be true if your child dies, as private student loans are not typically forgiven by death; the lender could require you to repay the debt after your child has passed away. And unlike other types of debt, student loans are not discharged by bankruptcy, so you could still be responsible for the student loan if your son or daughter goes bankrupt.
A high percentage of student loans are currently in default. More than 11 percent of federal student loans are in default, and nearly 3 percent of private student loans are in default. If you cosign a student loan for your children, you are tying your credit score to theirs — if they miss payments, become delinquent or go into default on their private student loans, it could destroy the credit score that you have spent a lifetime building.
Many lenders do allow a cosigner to be released from a loan once a borrower has made a certain number of on-time payments and has demonstrated an ability to repay the loan. However, the better course of action is to avoid cosigning a private student loan whenever possible. Cosigning a loan puts your financial stability and your credit score at significant risk; even if your child is incredibly responsible, if something happens that leaves them unable to pay their student loans, such as an accident, it could mean that you are now required to pay off their student loans.
Instead of cosigning private student loans, look for alternatives. Help your child build up a credit score responsibly, perhaps by putting them on as an authorized user on your credit card, or helping them take out a car loan and ensuring that they make regular, on-time payments. Alternatively, encourage them to consider college options that are more affordable and will not require them to take out substantial student loans. Talk to the school financial aid office about options such as work study, grants and other opportunities that may lower the overall cost and help you avoid taking on the burden of cosigning a private student loan.
Helping your child pay for college is an admirable choice, but doing so should not put you at financial risk. That is why you should avoid cosigning private student loans, and seek out alternatives to cosigning whenever possible.
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- While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.