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. Cosigning means combining incomes and increasing the odds of an approval and better interest rates.
Unfortunately, this common practice is not usually the best choice. 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. Student loans can have a huge impact on a borrower’s ability to qualify for a mortgage.
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 matters.
This problem applies not just to purchasing a home, but other credit applications as well.
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: Divorce
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. That means that even if your ex is legally required to pay the debt, but fails to, it can affect your credit.
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.
Alternatives to Cosigning Loans
Many lenders want borrowers to get their loans cosigned. Having a cosigner means they have two people legally responsible for the debt instead of just one.
The good news is that the student loan refinance marketplace is extremely competitive and lenders know that not all borrowers are willing or able to find a cosigner.
Avoiding a cosigner requirement means shopping around by checking rates with a number of different lenders. We currently track over 20 different lenders and normally recommend that borrowers check rates with 5-10 lenders in order to ensure they are getting the best rates available.
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.