In many marriages, partners pool their money together. They both pitch in their earnings and consider any debt as something they both have to deal with. So, it might seem obvious to help your spouse out by cosigning their student loan, especially if it means you could get a better deal on interest rates by joining forces.
Unfortunately, this common practice is not usually the best choice. There are two main reasons.
Reason #1: Getting Credit in the Future
Buying a house is often the biggest purchase couples make. To make sure they can afford their dream home, it’s smart financial planning is crucial. Surprisingly, student loans can have a significant impact on a borrower’s ability to qualify for a mortgage.
In theory, a couple’s ability to afford a home should not change whether or not they cosigned their spouse’s student loan. In reality, however, it matters.
This issue isn’t just about buying a house; it affects getting any kind of loan.
Imagine you’re buying a $25,000 car with your spouse. If both of you sign the car loan, that $25,000 shows up on both of your credit reports. When the time comes to apply for a mortgage or any other credit, lenders will look at your debt-to-income ratio. The monthly payment on that car loan will have a negative impact on your debt-to-income ratio. It will have the same consequence for your spouse.
Some lenders may try to tell you that they won’t double count your debts, but due to lending automation, that is a very tough promise to make. A computer using a fixed formula makes most credit decisions. These systems provide very little room for human input, and they are far from perfect. As a result, double counting of shared debt is a genuine problem.
Important Note: These cosigning issues apply to both new in-school student loans and refinanced loans.
Reason #2: Divorce
Thinking about divorce is the last thing on a married person’s mind, but with the high divorce rates, it’s a reality that needs to be factored into financial planning. Many couples choose to form a prenuptial agreement for this very reason.
Cosigned debt, particularly student loans, can become a huge mess if a couple splits. Here’s why:
Firstly, student loans are sticky; even with recent policy improvements, they complicate a bankruptcy, which can sometimes follow a divorce. This means that long after you’ve cleared other debts, student loans can still haunt you.
Secondly, your bank or lender doesn’t care about your personal drama. If you cosigned a loan with your spouse, and then you two split, you’re still responsible for that debt. A divorce doesn’t free you from your loan obligations. Legally, you’re stuck with the debt no matter how your relationship changes.
Thirdly, many don’t realize that prenuptial agreements or divorce court decisions don’t affect your dealings with your lender. Even if a divorce decree states your ex should pay off the student loan, you’re still liable as a cosigner. If your ex doesn’t pay, it’s your credit score that suffers. Sure, you can try to recoup your losses by taking your ex to court if you end up paying, but it’s a complicated and messy ordeal.
In summary, divorce courts can divide assets and debts, but they can’t change the names on a loan contract. If your former spouse doesn’t keep up with payments, the lender will look to you for money. You’re left with two choices: pay off the debt or risk damaging your credit. Either way, if you do pay, attempting to get that money back can be a complex and unpleasant process.
Alternatives to Cosigning Loans
Lenders often prefer loans to have a cosigner because it means there are two people legally responsible for paying back the debt, not just one.
The silver lining is that the student loan refinancing market is very competitive. Lenders understand that not everyone can or wants to have a cosigner.
To get around needing a cosigner, the key is to compare offers from multiple lenders. This site tracks over 20 lenders and recommends that borrowers check rates with between 5 to 10 lenders to make sure they’re getting the best rates possible.
Avoiding and/or Fixing a Mistake
If you are thinking about refinancing your student loans with your spouse, carefully consider your options. The risks are genuine, and they are significant. The potential reward, a slightly lower interest rate, hardly justifies the many possible negative consequences.
If you have already cosigned your spouse’s student loan debt, the good news is there are several strategies that can be used to remove cosigners from loans.
