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The One Time it Makes Sense to Have a Cosigner for a Refinance Loan

Michael Lux Blog, Refinance, Strategy 0 Comments

I’m not a fan of having cosigners on loans.

It is a huge commitment for the cosigner, and if the borrower runs into trouble, it can destroy a close relationship.

Lenders like to advertise cosigner release programs, but they have almost no incentive to grant a release, and securing the release is usually a long shot.

From a financial perspective, cosigning a loan is a ton of risk with minimal upside.

When Getting a Cosigner is a Good Idea

If the general rule is that having a cosigner is a mistake, there is one noteworthy exception.

In a few cases, a refinanced loan with a cosigner can make things better for both the borrower and the cosigner.

I think a cosigner makes sense if the following are all true:

  • The borrower is refinancing existing loans that already have a cosigner,
  • The borrower cannot refinance the loans on their own, and
  • By refinancing, the borrower increases the chances that they will successfully pay off the loan.

The above circumstances will most commonly appear for relatively recent graduates who discover that they are struggling to keep up with their private loan payments. Because they recently finished school, they may be facing a lot of debt on an entry-level salary. These conditions make getting approved for a refinance loan difficult.

Why this Strategy is Smart for Borrowers

The big advantage to any refinance is that the borrower has an opportunity to improve loan terms. This could mean a lower interest rates, lower monthly payments, or both.

However, refinancing an existing loan with the same cosigner has one additional advantage. It shows the cosigner that you understand that they have made a big commitment and that you are doing your best to see to it that they do not regret helping you out. For a borrower struggling to keep up, showing this initiative can put a cosigner at ease.

Why this Strategy Works for Cosigners

In an ideal world, the borrower can refinance without the cosigner and the cosigner’s obligation is eliminated.

When eliminating the cosigner isn’t an option, improving the loan through a refinance is the second-best alternative.

One advantage to the cosigner is that finding a new loan with better terms means that the borrower is less likely to fall behind on the loan. This is huge because things can get complicated if the borrower isn’t able to make the required payments. Once the lender calls the cosigner about the debt, the cosigner is put in a difficult position. They can either pay the bill themselves, or they have to act as the debt collector on behalf of the lender and encourage the borrower to make payments. Improved loan terms can help cosigners avoid a messy situation.

Another immediate advantage to the cosigner comes when the borrower selects a loan with lower monthly payments. Because the loan appears on the cosigners credit report, the lower monthly payment will help the cosigner’s debt-to-income ratio should he or she apply for future credit. If the cosigner is about to apply for a mortgage, helping a borrower qualify for lower monthly payments can help the cosigner qualify for a larger mortgage.

Finding the Best Loan with Your Cosigner

One of the most frequent suggestions on this site is to shop around to find the best deal. Every lender has their own process for evaluating applications, and the only way to know who is actually offering the best rate is to apply.

This tip is especially important for borrowers who want to refinance and have a cosigner. Some lenders may see a cosigner on the application and approve a previously rejected borrower, but it comes with a higher interest rate. Other lenders may factor in the credit score and income of the cosigner and offer the previously rejected borrower excellent loan terms.

Finding the best rate is only part of the discussion for cosigners and borrowers. They must also decide on the loan length and type. Generally speaking, the longer the loan length, the more important it is to select a fixed-rate loan. Additionally, borrowers must way the lower interest rates of shorter loans against the lower payments and higher interest rates that come with longer loans. A five-year loan may have excellent interest rates compared to a 20-year loan, but the monthly payments will be much higher.

At present, the shorter loans have interest rates that start around 2%, while the loans with the lowest monthly payments will start at about 5%.

The Simple Truth

If a cosigner is currently on your student loans, asking them to cosign on a refinance isn’t a huge request. They are already liable for the debt, refinancing just means they are liable for debt with slightly better terms.

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