Cosigning for Student Loans
By Joe Messinger, CFP®
January 10, 2019
Should a parent cosign for a private student loan?
When talking about paying for college, student loans almost always need to be a part of the conversation. Not too many of us can afford $25,000 (or more!) every year to pay for college out of our pockets or our savings. The go-to, first choice place for student loans is the Federal Direct Loan Program. There is no credit check, relatively low interest rates, and flexible repayment options. (Read more about some basic loan information.) However, the amount a student can borrow is capped at a certain amount each year, and a total of $27,000 total over 4 years. Need more than that? Families will need to turn to private loans with their income and credit criteria and their co-signer requirements.
Parents need to keep in mind that students will probably not meet the income or credit criteria required to qualify for a private student loan issued by an outside lender. According to MeasureOne, “roughly 94 percent of undergraduate private student loans included a cosigner in academic year 2015-16.”
A cosigner is ultimately responsible for the payment of the loan in full should the student be unable to pay. A cosigner is promising to pay the loan themselves, and their credit score could be impacted by late payments or default.
The borrower is also at risk.
Consider this, a borrower, the student, can become in default on a loan when the cosigner, often their parent, dies–even if they have been making all their payments on time. The bank could consider the loan in default when either party dies. Releasing the cosigner from the loan is a good idea for the borrower, too.
How is a cosigner released from the loan?
Contact the lender to get the details about the process to release a cosigner from the loan. Typically they are going to be looking for as much as 3 to 4 years of payments and income history from the borrower in order to release the cosigner. This depends on the total liability still outstanding to the bank and credit worthiness of the borrower. Sallie Mae has their release process online as an example. Another option is to refinance the loan if it makes smart financial sense. These days there are a variety of niche education lending organizations that have popped up in the last few years like Sofi, Earnest, and Common Bond to name a few.
Does the parent have poor credit? Apply for a Parent PLUS loan anyway.
One of the federal loan options available is a Parent PLUS loan. In general we use these loans as a last resort and/or funding a small gap. This fixed interest rate loan should be compared to a private loan when determining the best mix. These loans have an up front loan fee in excess of 4% and a fixed interest rate of 7.6% for the 2018-19 academic year. These rates are reset each year on July 1. A Parent PLUS loan is in the name of the parent, not the student, and will not and cannot be transferred to the student after they graduate. If a parent has poor credit and is denied a Parent PLUS loan, which is typically due to a recent bankruptcy, the student is eligible for an addition $4,000 per year in federal loan amounts. It is one time when being turned down for a loan could have an upside.
Let’s avoid the cycle of debt.
Sometimes parents pass on their bad habits to their kids. We leave a dirty glass on an end table. We forget to turn off the light when leaving the room. Our children learn from us and leave their own dirty glasses around or lights on.
More seriously perhaps we have poor money management skills and bad financial habits making poor spending choices, not planning for the future, or just not understanding how it all works. Quite frankly, these are skills we are never taught unless we seek out the knowledge on our own. The buck can stop with you. End the cycle of debt with your generation. Help our children learn from us in a good way when it comes to our financial habits. Share our struggles as challenges that they can learn from and not repeat again to break the cycle of debt. Have the conversations needed about paying for all four years of college and make a smart plan to do so with the best financial decisions in mind for the future.