Having a c0-signer on a student loan can be the difference between and approval or a rejection. It can also help a borrower qualify for a lower interest rate. Unfortunately, there are many dangers associated with co-signing student loans. Before co-signing a student loan, both the borrower and the c0-signer should understand the problems with co-signing a student loan and the ways to reduce the risks.
Warning #1: Planning on a Co-Signer Release is a Huge Risk
Many lenders advertise a co-signer release after just a few years of on time payments. However, if you look at the fine print on the agreements, you will see that the borrower also has to meet credit requirements for the co-signer to be removed from the loan. This means the borrower will need a good credit score, and debt-to-income ratio.
The problem with this credit decision is that it is one made by the lender, and the lender has almost no incentive to release the co-signer. With a co-signer, the lender has two people legally responsible for paying off the debt. With the co-signer removed, that number drops to one. A recent study conducted by the Consumer Financial Protection Bureau found that these releases were rarely ever granted.
When a student loan is first co-signed, all parties should understand that there is a very real possibility that co-signer will be on the loan until it is paid in full. Once the borrower has a solid credit score and income on their own, they should consider refinancing the loan with another lender in addition to going after a co-signer release. Both routes end up with the co-signer being removed from the loan.
Warning #2: Credit Score Implications
Any co-signer should understand that co-signing a loan could impact their ability to get credit in the future. All co-signed student loans will appear on your credit report.
Most credit decisions today are based upon a computer formula. This means if you are trying to qualify for a mortgage or a car loan, the numbers get punched into a computer, and it spits out an answer. Often, co-signed loans will show up as a monthly payment in this calculation. This can alter your debt-to-income ratio because it shows more debt that what you actually have to pay each month. The end result is a reduction in ability to borrow.
Some lenders will allow you to submit records showing that the borrower has not missed payments and doesn’t require help with the loan, but this process can be time consuming and not all borrowers will exclude the co-signed loan from their calculation.
Warning #3: The Risk of the Death of the Borrower
Pondering death is never a pleasant subject, especially if that person is your child or grandchild. Unfortunately, this is a subject that must be considered by anyone who is considering co-signing a student loan.
How lenders handle the death of a borrower can vary greatly. Some lenders will expect the co-signer to pay back the loan in full even if the borrower is dead. Others will forgive the loan completely. Some lenders will evaluate it on a case by case basis.
If you are going to co-sign a student loan, it is critical to know how the lender will handle this situation. Unless it says in the loan agreement that the loan is forgiven if the borrower dies, you should operate under the assumption that the lender will expect you to pay the bill. Even if they say something else over the phone, it does not make a difference. These agreements all have a contract provision that says if it isn’t written in this agreement, it isn’t part of the agreement. That means it is dangerous to rely on what a customer service representative says before you sign on the dotted line.
If the loan contract does not have a provision that protects the co-signer in the event of the death or permanent disability of the borrower, a co-signer can still protect himself or herself. One form of protection would be to take out a life insurance policy on the borrower in the amount of the co-signed loan. For young healthy individuals, these policies can be purchased cheaply. If the extremely unfortunate happens, the co-signer will be in a position to pay off the loan in full.
Asking someone to co-sign a loan is more than just a small favor. It is a huge financial commitment that can have implications for years to come.