In most marriages, couples share their finances. Each spouse contributes their income to the family coffers, while each spouse treats the other’s debt as a shared obligation. Because of this shared effort to pay off debt, cosigning a spouse’s refinanced or consolidated student loan sounds like a no-brainer. Cosigning a spouse’s student loans means combining incomes and increasing the odds of 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 a house. Responsible personal finance for most couples should include finding ways to ensure they can afford the mortgage for the home they want. 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 problem applies not just to the purchase of a home but to 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 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
The last thing a married person wants to think about is divorce. However, with the divorce rate at its current level, it is a possibility that couples should consider during financial planning. Many couples choose to form a prenuptial agreement for this very reason.
Cosigned debt gets extremely ugly in a divorce… especially student loans. Several factors contribute to this issue.
First, student loans usually cannot be discharged in bankruptcy. Because bankruptcy is frequently a consequence of a divorce, it is worth noting that student debt can linger long after the credit cards, car payments, and mortgages are eliminated.
Second, the banks and lenders don’t care about the relationship between you and your cosigner. Suppose Fred is your husband and you cosign a loan with Fred. You are still on the hook for the loan if you and Fred divorce. Divorcing Fred does not release you from your obligation. If you cosign a loan, you are legally responsible for the debt even if your relationship with the borrower changes.
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 consider. When you and Fred get divorced, even if the divorce court says that Fred is responsible for paying off his student loan, you are not released as the cosigner. So, even if your ex is legally required to pay the debt, your credit can be affected if he fails to do so.
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 apparent that it is an ugly process.
Alternatives to Cosigning Loans
Many lenders want borrowers to have a cosigner for their loans. 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 exceptionally 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 several different lenders. We currently track over 20 different lenders and normally recommend that borrowers check rates with 5-10 lenders to ensure they are getting the best rates available.
Avoiding and/or Fixing a Mistake
If you are thinking about refinancing your student loans with your spouse, think again. 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.