Cosign Student Loans with Caution

By Mark Kantrowitz

Traditional college students, who enroll in college immediately after graduating from high school, usually don't have enough of a credit history to qualify for a private student loan on their own. Accordingly, more than 90% of undergraduate private student loan borrowers need a creditworthy cosigner. Even among graduate and professional school students, more than 75% of private student loan borrowers need a creditworthy cosigner.

Benefits of Having a Cosigner

A cosigner is a co-borrower, equally obligated to repay the debt.

The lender uses the higher of the borrower's and cosigner's credit scores to determine eligibility for a private student loan. Borrowers who apply with a creditworthy cosigner are more likely to be approved.

If the borrower is approved, the higher of the two credit scores is also used to determine the interest rate and fees on the loan. This can help the borrower qualify for a lower interest rate.

Thus, even if a borrower can qualify for a private student loan without a cosigner, it is worthwhile to apply with a cosigner. If the cosigner has a better credit score than the borrower, this can yield a lower interest rate on the loan.

In addition, adding a cosigner to a private student loan can yield a lower interest rate even if the cosigner doesn't have a better credit score than the borrower. Some lenders will reduce the interest rate on a private student loan by as much as 0.5% because having a cosigner reduces the risk of default. Borrowers are less likely to default on a student loan if they know that the cosigner will be required to make the loan payments.

Who Can Be a Cosigner?

Anybody who satisfies the lender's credit underwriting criteria can be a cosigner. The requirements for cosigners can be found on each lender's web site.

Usually the cosigner must be a U.S. citizen or permanent resident with a valid Social Security Number. The cosigner must have been employed in the cosigner's current job for at least a year. Most lenders require the cosigner to have income above a specified threshold.

A cosigner can be a parent, aunt, uncle, older sibling, spouse, grandparent, cousin or other relative. A cosigner does not need to be related to the borrower, however, and can be a close personal friend. Most often the cosigner will be a parent.

The cosigner must be willing to serve as a cosigner and must have very good or excellent credit (i.e., a credit score of 750 or more).

The Risks of Cosigning a Student Loan

Warning: Cosigning a student loan may be hazardous to your wealth.

Many cosigners incorrectly believe that they are merely providing a reference for the borrower to enable the borrower to qualify for a private student loan and to get a lower interest rate. Actually, by cosigning the loan, the cosigner is agreeing to be independently and fully responsible for repaying the student loan. If the primary borrower stops making payments or is late with a payment, the lender will immediately seek repayment from the cosigner.

A cosigned loan will be reported as the cosigner's loan on the cosigner's credit history. Since the cosigner is responsible for repaying the loan, it really is the cosigner's loan. This has several consequences:

• The Cosigned Loan will Affect the Cosigner's Ability to Get New Credit. Since the cosigned loan counts as the cosigner's debt, it may prevent the cosigner from qualifying for new credit or from refinancing a mortgage.

  There are a few workarounds. Since mortgage lenders focus on the ratio of the monthly payments to monthly income, reducing the monthly payment may help. The monthly payment may be reduced by using an alternate repayment plan like extended repayment or income-driven repayment. The cosigner could ask the borrower to apply for cosigner release. The cosigner could also ask the borrower to refinance the cosigned loan into a private consolidation loan without a cosigner.

• The Cosigned Loan can Ruin the Cosigner's Credit History. Cosigning a student loan is like giving your child the keys to your financial future. If the borrower is late with a payment or defaults on the loan, it will ruin the cosigner's credit score, not just the borrower's. Accordingly, it is important for the cosigner to monitor the loan to ensure that the borrower manages the debt responsibly and makes all of the payments on time.

A cosigner's obligation to repay a cosigned student loan is almost impossible to discharge in bankruptcy, just like the borrower's obligation to repay the debt.

Although many lenders of private student loans offer cosigner release as an option, qualifying for cosigner release is very difficult. Less than 10% of borrowers apply for cosigner release, and less than 10% of applications for cosigner release are approved. Thus, less than 1% of borrowers qualify for cosigner release.

Dos and Don'ts of Cosigning a Student Loan

Do not cosign a loan:

• If you can't afford to repay the loan entirely on your own, without any help from the borrower.
• If you will be on fixed income when the loan enters repayment. Lenders rarely consider whether the cosigner is near retirement age.
• If you have low income. Although lenders require cosigners to have a steady job and to earn more than a specified amount, the income threshold is minimal. Since many lenders do not consider debt-to-income ratios, satisfying the lender's credit criteria does not always mean the cosigner is capable of repaying the debt.
• If you have too strong an emotional attachment to the borrower, as it may cloud your judgment. Ask yourself if you'd still cosign the loan if the borrower were a complete stranger.

If you are thinking about cosigning a student loan, do the following:

• Read the loan documents carefully. Sometimes, cosigning a loan authorizes the borrower to obtain additional loans each year of a continuous period of enrollment, not just the current loan amount.
• Get life insurance on the borrower. If the loan does not provide a death discharge, the cosigner could be left responsible for the loan if the borrower dies. The cosigner should obtain a term life insurance policy on the borrower with a face value equal to the loan amount and a term equal to the repayment term. This life insurance policy will pay off the cosigned student loans if the borrower dies. The cost of such term life insurance should be low, if the borrower is young and healthy.
• Emphasize that the cosigned loan is not a gift. Before cosigning the loan, require the borrower to sign an agreement to reimburse the cosigner for any payments made by the cosigner on the cosigned loan.

Questions to Ask before Cosigning a Student Loan

Before cosigning a loan, ask a few questions about the borrower:

• Is the borrower trustworthy?
• Is the borrower organized and responsible?
• Does the borrower honor his or her obligations?
• Does the borrower fulfill his or her commitments?
• Does the borrower treat debt seriously?
• If the borrower has a credit card, does the borrower pay off the balance in-full each month?
• Will the borrower make the monthly payments on time, every time?
• Has the borrower undergone financial literacy training?

The cosigner might also want to ask questions about the private student loan, such as the interest rate, loan amount, repayment term and whether it offers a cosigner release option.