College is expensive, and costs are only rising. For many students, taking out a loan is a necessary part of obtaining a college or graduate degree. But for many young Americans without a solid credit history, it can be difficult to get student loans without a cosigner. It may be necessary to have someone else, such as a parent, family member or friend, co-sign loans in order to get a low interest rate.
Co-signing student loans is often the best way to get low interest student loans that may be required to cover any shortfall between tuition, financial aid, grants or scholarships and federal loans. The co-signer is usually older, with a better-established credit history and higher credit score.
Having a co-signer on the loan enables the borrower to get a better interest rate because the lender is more confident that the loans will be repaid. While the advantages of co-signers is clear, anyone who is asked to co-sign a loan should carefully consider the risks of doing so. Here are six factors to weigh before agreeing to co-sign a student loan.
Co-Signing is More Common Than Ever
The price of a bachelor’s degree has risen considerably over the past decades, far outpacing inflation for most colleges and universities. Despite these ever-increasing costs, the federal student loan limit is relatively low at $31,000. That means that students can only borrow a total of $31,000 through federal student loan programs — which is equivalent to $5,500 to $7,500 per year. Subsidized and unsubsidized Stafford loans tend to have lower interest rates and better repayment options — but they usually do not cover anywhere close to full tuition and living expenses for college students.
Even lower cost public universities cost far more than $7,500 in annual tuition — which means that many families are turning to private loans to make up the difference between tuition, financial aid and federal loans. Private loans can have much higher interest rates than federal loans, particularly for those students who are young and do not have any credit history. A co-signed loan can help the student obtain much lower interest rates — which is why more and more families are agreeing to co-sign loans for their children.
Qualifying for a Private Loan Can Be Difficult for Students
Most college students begin their higher education directly after high school — and some may not even be 18 when they leave home. Most high school students do not have a credit history, which is built over time by borrowing money and repaying it, such as through a car loan, credit card, personal loan or mortgage. Without a solid credit history, lenders will not approve teenagers for private student loans.
As a result, most students will not qualify for loans without a co-signer. This is because lenders cannot evaluate their risk as borrowers since they rarely have a credit history. The overwhelming majority of private undergraduate student loans have a co-signer for this reason. If your son or daughter is applying to go to a college or university with high tuition, it is possible that you will have to co-sign any private loans.
Lower Interest Rates for Co-Signed Loans
The major advantage of a co-signed student loan is that the interest rate is usually far lower than a loan with just the student on it — if the student can even be approved for a private loan. In most cases, the interest rate can drop by more than two percent just by having a co-signer.
For many parents, co-signing a student loan with their child makes more sense than taking out their own private loan, such as a parent PLUS loan. These loans tend to have a higher interest rate and origination fee than co-signed student loans, making it a more expensive choice than co-signing a loan that is taken out in your child’s name.
Co-Signers Are Liable for the Loan
Of course, co-signing loans has a major drawback: if you co-sign a loan, you are on the hook for repaying it. That is something that anyone considering co-signing a loan should carefully evaluate. If you are unwilling or unable to pay back the loan if the student cannot or does not take responsibility for the payments, then do not co-sign.
A co-signer assumes equal responsibility for a student loan. If the primary borrower does not repay the loan or goes into default, the co-signer can take the hit with a bad credit score. He or she will then be responsible for paying back the loan if the borrower does not pay. This could be a major burden to the co-signer, who often did not anticipate being stuck with a student loan payment each month.
An Agreement is Necessary to Ensure a Successful Repayment
Almost anyone can agree to co-sign a loan for a student — a parent, sibling, grandparent, other relative or friend. But just because someone can co-sign for a student loan does not mean that they should. It is incredibly important that the co-signer and the borrower clearly communicate their expectations and agree to a repayment plan that will ensure that the loan is paid — and that the co-signer isn’t on the hook for the loan.
The agreement does not have to be formal or written. But the borrower must understand that even though you have agreed to co-sign the loan, it does not mean that they do not have to pay it back. Talk openly about expectations, and ask the borrower to keep you informed about their ability to pay back the loan.
Importantly, many lenders primarily communicate with the borrower — not the co-signer. That means that many co-signers do not find out that the loan is in default until after it has already happened and their credit score has been impacted. Make sure that the borrower is aware of how this will affect you — and that they keep you updated on their progress.
A Release May Be Possible
Once a student has graduated and starts making regular, on-time student loan payments, the co-signer may be able to remove his or her name from the loan. Many student loan companies have a co-signer release program that permits the borrower to essentially re-apply for the loan under their own name. If the borrower can demonstrate that he or she is able to repay the loan, then the co-signer may be released from responsibility for the loan.
If you have been asked to co-sign a private student loan, ask about a release program — and talk to the borrower about setting goals to qualify for the loan on his own. Once a release has been obtained, then the borrower is no longer liable for any portion of the loan.
Author: Jeff Gitlen
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