Pros And Cons Of Co-signing A Student Loan

Deciding whether or not to be a co-signer on a student loan requires careful consideration. After all, you are legally obligated for your student’s debt if he or she cannot pay it. Before you decide whether co-signing is right for you, be sure to understand the risks you’ll encounter when you sign on the dotted line of a loan application.

Who Can Co-sign a Loan?

A student loan co-signer is typically a parent or guardian, spouse or another relative, or perhaps a close family friend of a borrower. Generally, the only required criteria are that the co-signer is of legal age, is a U.S. citizen and is joining the loan without duress. But ideally, a co-signer will also have strong credit and income in order to help the primary borrower qualify for a loan.

Student loans cover a college or graduate education, and if the student doesn’t have good credit or a strong credit history—and has exhausted all federal loan options, which typically don’t require a co-signer—co-signing a loan may be the only way to secure a private student loan to assist with college expenses.

How to Decide Whether you Should Co-sign a Loan

When you co-sign a loan, the student borrower stands to benefit more than you. Before agreeing to co-sign a loan for your child, niece or nephew, spouse or friend, carefully think about the commitment and implications.

“It is a highly emotional decision, yet the financial consequences are often overlooked or not understood,” says Fred Amrein, an expert in college funding and student loans and the CEO and founder of PayForED, a technology firm that helps student maximize financial aid. “Many times these are not recognized until the default occurs or the co-signer tries to finance something for themselves.”

When you’re a co-signer, you need strong credit. Lender requirements vary, but most institutions require co-signers to have a credit score of 670 or better and income reserves in case the primary borrower defaults. Other factors typically considered include job history, credit history or how long a co-signer has resided at or owned their home.

Benefits of Co-Signing a Student Loan

Being a student loan co-signer offers several advantages. Here are some important reasons to consider co-signing a student loan:

• The student becomes a better loan candidate. Lenders generally require positive credit history, income requirements, collateral, cash reserves or a reasonable debt-to-income ratio. A college student is unlikely to be able to meet these lending thresholds. With a co-signer, however, the situation is less risky for lenders and they will take into consideration your credit history, income and other factors.
• The student may qualify for a lower interest rate. When you are added to the loan application with your student, your creditworthiness can impact the interest rate the lender offers. A lower interest rate will impact the cost of the loan, and it may qualify the student for a larger loan.
• The student will build their credit. By making on-time loan payments, your student will build a positive credit history. These positive actions can help your student build a good credit score, which can lead to lower interest rates on property, cars, credit cards and other types of loans.

Drawbacks of Co-signing a Student Loan

There are some significant risks associated with co-signing a student loan. Here are the largest disadvantages:

• Your debt-to-income ratio will be impacted. When you take out any loan, or co-sign a loan, debt liabilities come into play. Becoming a co-signer on a student loan for another borrower can make it more difficult for you to take out a loan later. For example, if you want to buy a car or purchase a vacation property, lenders will assess your debt-to-income ratio—your monthly debt obligations versus how much money you take home. Student loan debt, even if it’s on a loan you co-signed, impacts that ratio.
• It’s your responsibility to pay off the loan. Since the co-signer is equally responsible for the loan, you’ll still be held liable if the primary borrower doesn’t meet the loan’s obligations. The loan will be included on your credit reports, and if you or the borrower pay late or miss loan payments, this will negatively impact your credit score. Besides the credit implications, there are legal implications. A court could hold you responsible for the debt, including for any applicable legal fees. Your only recourse at the end of a defaulted loan scenario could be to sue the primary borrower, which could be an uncomfortable prospect, especially if you and the borrower are related.
• You could face severe negative credit implications. If you’ve worked hard to build a good credit score, know that you could cause real damage to your credit if the student borrower stops paying on the loan and you don’t pay the debts. Private student loans may go into default as soon as you miss a payment.
• Your relationship can become strained. If the student fails to make payments, or even if the payments are late, your credit will be negatively impacted. This can hurt your relationship with the student. They may not realize the long-term implications, and your frustration can cause friction in your relationship. This is something that can change family dynamics.
• Credit blemishes stay on your credit report. If you or the borrower miss payments, the credit bureaus will keep this on your report for up to seven years—well after the potential damage to your credit score has ended.

“As a co-signer, the biggest risk of co-signing a student loan is that you’re relinquishing control of your credit rating to the student borrower,” says Alyssa Schaefer, chief marketing officer at Laurel Road, a private student lending platform owned by KeyBank. “Any missed payments can hurt your credit and can even cause collectors to come after you if payments are repeatedly missed. In the worst-case scenario, co-signing a loan could mean you’re responsible in the instance of the student borrower’s death or disability—another reason to read the fine print carefully to evaluate if your lender allows for forgiveness in such circumstances.”

What Is a Co-signer Release?

Before agreeing to be a co-signer, be prepared to remain one for the life of the loan. In some cases, however, you can obtain a co-signer release.

If you’re considering co-signing a loan, Schaefer advises to ensure the loan includes payment flexibility and a co-signer release, which is when the co-signer is removed from the loan agreement and is no longer responsible for the loan obligations.

According to the Consumer Financial Protection Bureau, some lenders release the co-signer from the loan once the primary borrower or student borrower makes a specified number of on-time payments and meets credit requirements, including passing a credit check.

Laurel Road, for example, offers a co-signer release after 36 consecutive on-time payments. The borrower must still meet lender underwriting standards, Schaefer says.

If your private loan doesn’t allow for a co-signer release, refinancing the student loan in the student’s name is another option. A refinanced loan allows you to remove the co-signer’s name and combine multiple loans into a single loan with a potentially lower interest rate.

The Bottom Line

Before you co-sign, have a discussion with the student about repayment expectations. Once they graduate, there should be a plan in place.

“A parent or family member opts to co-sign a student loan so that the borrower can pursue an advanced education,” says Dennis McNamara, financial planner and co-founder of wHealth Advisors in Red Bank, New Jersey. “From the very beginning, it should be understood that releasing the co-signer should be a priority following the borrower’s graduation.”