The dangers of co-signing a student loan
Seeing their kids off to college is a dream many parents share, but co-signing the student loan to get them there can have nightmarish consequences.
These days, many students need help to cover the skyrocketing costs of college. At public four-year schools, costs for the 2015–16 school year rose to $19,548 from the $16,178 price tag five years ago, according to the College Board. Tuition plus room and board at four-year private universities was much, much higher: $43,921 on average.
In turn, student debt has reached record proportions, with $1.3 trillion in student loans outstanding.
While private student loans make up only a portion of that, they are often used by borrowers who also have federal loans. Generally, private student loans have higher variable interest rates, lack flexible repayment options, and most require a cosigner.
That's when parents step in and put their own financial stability and retirement at risk in the process.
"Parents and grandparents put their financial futures on the line by co-signing private student loans to help family members achieve the dream of higher education," said Richard Cordray, director of the Consumer Financial Protection Bureau, in a recent statement.
Approximately 90 percent of private student loans are co-signed by a parent, according to a 2012 report by the CFPB and the Department of Education. That's up significantly from previous years.
A creditworthy cosigner helps in many ways — primarily by being able to access credit and by getting a lower interest rate— but they're also on the hook if the student is unable to repay the loan at any point. The loan also goes on the cosigner's record and counts toward their debt, which means it can also affect their credit score.
"Co-signing is essentially identical to taking on the loan itself; if it's not paid, your credit will be ruined and you can get hammered by debt collectors," said Rohit Chopra, a senior fellow at the Center for American Progress.
Nearly all, or 94 percent, of parents with a child in college said they feel an increased burden from their child's college debt, yet nearly half do not have a plan to pay for the debt and more than half of parents said it is putting their own retirement in jeopardy, according to a 2014 survey by Citizens Financial Group.
"Before co-signing a student loan, parents have to remember that they will assume equal responsibility for repaying the loan," cautioned Vince Passione, CEO of LendKey, a student loan refinancing site. "Late payments can affect their credit as well and not just their child's."
In fact, the lender can go to the parent first to recoup the full amount of the loan, noted Stuart Ritter, a senior financial planner at T. Rowe Price. "There's this idea that co-signing is a kind of backstop. It doesn't necessarily work that way."
Remember, that's why the bank asked the parent to sign on in the first place, Ritter said. "Often, the reason the lender wants a cosigner is because they don't think the primary borrower is creditworthy enough."
Plus, the bank is under no obligation to keep the co-signer up to date on the status of the loan, Ritter added. If the borrower has missed payments, the parent might not even know, despite their financial stake in the game.
Passione suggests exploring all of the options available to help finance a college education before cosigning for a private loan, including loans through the Federal Direct Loan Program that are in the student's name and ParentPlus loans, where the loans are solely in the parent's name and are not considered cosigned.
Some private loans also offer a co-signer release, which allows the cosigner to be taken off a loan obligation entirely after a set period of time as long as it's in good standing. Refinancing student debt is another way to remove the cosigner from the loan obligation — plus, it's also an opportunity to lock in a lower rate before variable rates rise.
These are conversations that should be had with your child upfront, Ritter said. Reinforce that this is their higher-education debt to repay, and "have some contingencies mapped out beforehand."