Each year, about 60 percent of enrolled college students borrow money to finance their education, according to the nonprofit group American Student Assistance. Many (though not all) of those students were able to get loans only because their parents or someone else cosigned for them. Cosigning a student loan can be a great help to a young person seeking an education – but it can carry great risk for the cosigner.
Federal v. Private Loans
There are two categories of student loans: government-backed and private. Government-backed loans are funded and administered by the federal government; private loans are offered by other lenders, such as banks, credit unions or schools. Government-backed loans generally don’t require cosigners; approval is based on students’ financial need rather than creditworthiness. But private loans often do require a cosigner.
Why Cosigning is Necessary
Students can rack up tens of thousands or even hundreds of thousands of dollars in educational debt while in college. This debt is unsecured, meaning there’s no collateral that a lender could seize if the borrower defaults on the loan. After all, you can’t repossess a college education.
Lenders usually assess the likelihood that a borrower will default on a loan by looking at that person’s credit report and credit scores. But since many young people haven’t yet built much of a credit history, they tend to have low credit scores. So a cosigner is often requested because private lenders want some kind of assurance that the loan will be repaid.
Assuming the Obligation
When you cosign a loan, you are promising the lender that if the primary borrower – in this case, the student – fails to repay the loan, then you will repay it. By cosigning a student loan, you are essentially allowing the student to borrow your good credit for the purpose of obtaining the loan. This isn’t a mere formality or a simple favor; it’s not like writing a letter of reference for someone. You are assuming a long-term financial obligation. If you cosign a $50,000 loan, you are assuming the obligation for $50,000 plus interest, if the student defaults.
Effect on Your Credit Report
After you’ve accepted the obligation by cosigning, the student loan debt will appear on your credit report, as well as on the primary borrower’s. All activity on the account will appear on your credit report, too. If the student makes payments on time, that will show up on your report. If the student pays late or doesn’t pay at all, that fact will also be recorded on your credit report, and it can lower your credit score.
When your credit scores can be affected by the primary borrower’s behavior, it’s wise to review your credit report periodically and track whether the student is making payments as required. And when you apply for a loan for yourself, potential lenders may consider the balance of the student loan when they consider extending you credit. You may have little debt of your own, but a loan officer reviewing your application for a mortgage or a car loan might be influenced by the presence of a large student loan balance on your credit report.
Student loans commonly provide a cosigner “release” option, which takes the cosigner off the loan and makes repayment the sole responsibility of the primary borrower. A release becomes possible under two conditions. First, the primary borrower must have demonstrated a commitment to paying off the loan by making a certain number of monthly payments on time – perhaps 12, 24 or 36 months in a row. Second, the primary borrower must have established good credit on his own. According to Bankrate, releasing the cosigner means the lender is approving the primary borrower for the full remaining balance of the loan. If the student’s credit becomes strong enough, the lender may release the cosigner.
As you plan to send your student off into higher education, it’s important to be realistic about the impact that having a college student in the family can toll on your finances. Considering the options early can help you avoid surprises that come from having to make last-minute decisions. You can work to maximize your financial wellbeing at the same time you help bring someone’s dreams of a college education to life.
About the Author
Cam Merritt has been a professional writer and editor since 1992, specializing in articles about personal finance and law. He has contributed to USA Today and the Better Homes and Gardens family of magazines and websites. Merritt has a Bachelor of Arts in journalism from Drake University.
This article is provided for general guidance and information. It is not intended as, nor should it be construed to be, legal, financial or other professional advice. Please consult with your attorney or financial advisor to discuss any legal or financial issues involved with credit decisions.
Published by permission from ConsumerInfo.com, Inc., an Experian company. © 2014 ConsumerInfo.com, Inc. All rights reserved.