For most couples, finances are shared. Income from either spouse is for the family, and debt for either spouse is treated as a shared obligation.
Because of this shared effort to pay off the loan, cosigning in a refinanced or consolidated loan sounds like a no brainer. By using the combined income of the couple, they are able to get the lowest possible interest rate and get the debt paid off faster.
Unfortunately, the seemingly obvious solution is not the best practice. There are two main reasons.
Reason #1: Getting Credit in the Future
The big purchase for most couples is the house. Responsible personal finance for most couples should include finding ways to make sure you can afford the mortgage for the house you want.
In theory, the ability of a couple to afford a home should not change whether they are cosigned on a loan or not. In reality, it can have an impact.
Suppose you and your spouse are buying a new car for $25,000. If you both cosign on the car loan, that $25,000 loan will appear on both 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 personal 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 in this day and age, that is a very tough promise to make. Most credit decisions are made by a computer using a fixed formula. There is very little room for human input. These systems are also far from perfect. As a result, double counting of shared debt is a very real problem, and one that should be avoided.
Reason #2: The D Word
The last thing a married person wants to think about is divorce. However, with the divorce rate at its current level, it is a very real possibility that should be considered in financial planning. Many couples choose to get a prenuptial agreement for this very reason.
Cosigned debt gets extremely ugly in a divorce… especially student loans. There are a number of factors that contribute to this issue.
First, student loans usually cannot be discharged in a bankruptcy. Because bankruptcy is often a consequence of a divorce, it is worth noting that this issue will linger long after the credit cards, car payments, and mortgage are eliminated.
Second, the banks and lenders don’t care about the relationship between you and your cosigner. If Fred is your husband, and you cosign on a loan with Fred, but then get divorced, you are still on the hook for the loan. Simply divorcing Fred does not release you from your obligation.
Third, prenuptial agreements and divorce proceedings will not alter your relationship with your lender. This is a huge factor that most people do not understand or think about. Going back to the Fred example, if you get divorced and the divorce court says that Fred is responsible for paying off his student loan, it does not release you as the cosigner.
The divorce court splits up assets and debts, but it does not alter existing contracts. If Fred falls behind on his student loan, the lender will come after you to collect. Your choice is to either pay the debt, or live with the negative credit. If you do pay the debt, you can technically take Fred back to court to get the money that he should have paid, but by now it should be pretty obvious that it is a very ugly process.
The Bottom Line
If you are thinking about consolidating your loans with your spouse, think again. The risks are very real, and they are major. The potential reward, a slightly lower interest rate, hardly justifies the many conceivable negative consequences.