Students using private student loans to fund their education often lack the credit history and income required to secure their loans on their own because they may not meet the lender's underwriting criteria.
According to Greg McBride, chief financial analyst at Bankrate.com, income and debt-to-income ratio are extremely important factors that banks use to determine who qualifies for their loans. However, many students applying for undergraduate and graduate school loans don't have any income or credit history and thus don't qualify. That's where cosigners come in.
A cosigner is someone who commits to repaying a loan if, for some reason, the primary borrower is unable to do so. Typically a cosigner is a parent, grandparent or another close family member of the primary borrower. The cosigner is effectively taking on the same debt (and therefore the same obligation) as a borrower. Credit bureaus consider this debt to be part of the cosigner's credit history, and it's counted as outstanding debt in factors like debt-to-income ratios, which could affect a cosigner's ability to qualify for other lending products.
A MeasureOne report found that about 94% of private undergraduate student loans in the 2015-16 school year were cosigned, and 61% of graduate private student loans included a cosigner. The cosigner was usually a parent or other close family member.
Here's what borrowers and potential cosigners should keep in mind when considering taking on student loans:
Cosigning a student loan has various advantages
Cosigning allows students who otherwise would not have access to loans to borrow for their education. For the primary borrower, there are various benefits to having a strong cosigner on a student loan, including:
- Increasing the amount the primary borrower can borrow for their education
- Helping the borrower establish a credit history if they don't already have one
- Helping the borrower take out a private loan, often with a lower interest rate than a federal loan, thus helping them save money.
A recent analysis by Credible.com, for example, showed that undergraduates with cosigners qualified for loans with interest rates averaging 5.37%, compared to 7.46% without a cosigner. The study also showed that graduate students with a cosigner were also able to get a better rate: 4.59% on average, compared to 6.21% without a cosigner.
Both parties involved need to understand the responsibility of cosigning
Because a cosigner is just as responsible for the debt as the primary borrower, cosigning is no small commitment, and it requires careful discussion and consideration between the both parties.
"The borrower and cosigner should have a clear understanding about whose responsibility it is to repay the loan the borrower and the consequences for the cosigner if the borrower runs into trouble making payments," said Stephen Dash, Founder and CEO of Credible. "Late payments can damage the cosigner's credit, and if the borrower walks away from the loan altogether, the cosigner is on the hook to pay off the remaining balance."
Here are some steps to ensure that both parties understand the responsibility involved with cosigning:
- Conduct due diligence and communicate: Before signing, potential cosigners need to make sure they understand the details of the loan, how responsible the primary borrower is with money, and why they need the help that comes with having a cosigner. It's important for both parties to set expectations in advance about how the borrower will behave and handle the debt responsibly, McBride says.
- Dig deeper: Cosigners should ask for a copy of the primary borrower's credit report to determine whether past issues affecting their credit are really in the past. It's risky for a cosigner to tie themselves to someone with bad credit, as it could end up negatively impacting the cosigner's own credit if the primary borrower makes late payments.
- Think and plan ahead: Cosigners need to make a point to discuss with the primary borrower how he or she will ensure having sufficient income to pay back the loan. If the cosigner is a parent, for example, this will allow the opportunity to discuss their childâ€™s career path and projected income after graduation.
- Keep an eye on things after you've signed: Ideally cosigners should be able to see details like the primary borrower's loan balance, and be notified about issues such as late payments. The cosigner should have access and be able to monitor if payments are being made on time, according to McBride. Some lenders, including CommonBond, enable cosigners to access the primary borrower's account and check on payments.
Parents should understand when to cosign vs. take out a Parent PLUS loan
Because student loan cosigners are often parents of students, parents should also weigh the pros and cons of cosigning a student's private loan versus taking out a federal Parent PLUS loan to pay for their child's education. Here are some of the primary differences:
How do parents determine which type of loan to choose?
If you're a parent and feel confident in your child's ability to repay a cosigned private student loan, then that could be the right option. An added benefit is that because of the equal responsibility between you and your child in repaying the loan, your child is more likely to have "skin in the game" and be more invested in their education. However, keep in mind that because you both have responsibility for repaying the loan and if for some reason your child cannot pay, this could have a negative impact on your credit. How do parents determine which type of loan to choose? If you would prefer to have full responsibility over the loan, then taking out a Parent PLUS loan could be the way to go. Even if you take out a Parent PLUS loan, some lenders, including CommonBond, allow parents the option to transfer the loan into their child's name once their child has been steadily employed and has solid credit.
Cosigner release can be an option at the right time
Cosigners may not need to stay tied to the debt forever. Some lenders, including CommonBond, offer cosigner release options that can free the cosigner from responsibility for the debt after a set period of on-time repayment by the primary borrower.
CommonBond's policy for cosigner release enables a cosigner to be released from obligation on the loan if the primary borrower makes consecutive, on-time payments for three years, or the applicant meets CommonBond's underwriting criteria on his or her own.
Because cosigner release policies and procedures vary from lender to lender, it is best to contact your lender directly and ask for the necessary information on how to qualify and apply for a cosigner release.
Cosigning student loans can be a win-win for everyone involved if it is done with proper diligence, planning and communication. If you are confident in the primary borrower's ability to repay the loan, cosigning can be a good way to help a student fund his or her education while building a good credit history.