Many parents are willing to do whatever it takes to help their child get an education. So when your college-bound student with a limited credit history has a difficult time obtaining a private student loan, cosigning may seem like a simple way to help them pay for college and possibly get them a better interest rate. Last year, nearly 93 percent of private, undergraduate student loans included a cosigner, according to MeasureOne, a data company that tracks student loans.
However, there are several things you should know before signing on the dotted line. Here are some answers to common questions about cosigning student loans.
1. What does it mean to be a cosigner on a loan?
As the cosigner of the loan, you and the student are both responsible for the full amount borrowed. Even if you've agreed that the student will make all or some of the payments, in the lender's eyes, you're equally liable. If at some point your student doesn't or can't meet the loan obligation, a lender will expect you to make payments.
2. Who can cosign a student loan?
Parents are the most common cosigners for student loans, but they're not the only ones. Other relatives, family friends or any creditworthy individual can cosign as long as they meet the lender's eligibility requirements. As a cosigner, you have a vested interest in the student's educational success, so you should know the student well. You should also be comfortable discussing finances with them.
3. What are the benefits of cosigning a student loan?
When a cosigner with an established credit history cosigns a student loan, the student may receive a lower interest rate. Even a 0.25 percent reduction in the interest rate can save hundreds or thousands of dollars in interest over the life of the loan.
Cosigning also helps the student establish credit, and on-time payments will improve the credit scores of both the student and cosigner. That means the next time the student applies for a loan, it may be easier to do so without a cosigner.
4. Can a student get a loan without a cosigner?
Getting a private student loan without a cosigner is possible, but it's not always easy. Lenders look for applicants with an established credit history, good credit and the ability to repay the loan. Future college students with little-to-no income and no credit history may not meet the lender's criteria.
5. How much can you afford to borrow?
In general, you don't want to borrow more than you can afford to pay back before you retire. If you have a lot of other debt, have several students that need assistance with their loans or are behind on your own retirement savings, you may not be able to or want to cosign on a large loan. Consider consulting a financial advisor to determine how cosigning could affect your financial situation.
6. How is a cosigner's credit affected?
The cosigned loan amount will become part of the total debt that lenders look at when deciding whether you qualify for additional loans or credit, such as a mortgage, small business loan or car loan. Even if all loan payments are current, a high balance could impact your ability to qualify for a future loan or prevent you from qualifying for the lowest interest rate.
Payment history is one of many factors that go into determining your credit score, so if your student misses a loan payment, your credit score may be affected negatively.
7. Can a cosigner deduct interest on a student loan?
You may be able to take a tax deduction for the interest you pay on student loans for which you've cosigned if all of the following apply:
- You paid the interest
- You're legally obligated to pay the loan (cosigners are legally obligated)
- Your filing status is not Married Filing Separately
- Your Modified Adjusted Gross Income is less than $80,000 for a single filer or $160,000 for a married couple filing jointly. IRS rules completely phase out deductions for taxpayers with income over these amounts.
Consult a tax professional for tax advice. Please also see IRS Publication 970 for more information at irs.gov.
8. What happens if your student stops paying?
While 98 percent of today's outstanding private student loans are currently being paid on time, according to the Consumer Bankers Association, if your student does stop repaying the loan, you'll need to take over the remaining payments. Before you agree to be a cosigner, consider how that situation could affect your relationship with your student and how making the payments could impact your own financial situation.
Talk through a worst-case scenario well ahead of time to help both of you feel more comfortable with the arrangement. For instance, what if your student has trouble finding a job after graduation or runs into other financial difficulties that make repayment impossible? If you make loan payments on their behalf during that time, will they be obligated to repay you later on? Determine how the student intends to pay back their loan, whether they expect a financial contribution from you, and what access you will have to the loan documentation and account history. Setting expectations from the start can help you avoid financial and emotional stress down the line.
Before cosigning a loan, make sure you know all the facts, and make a realistic plan for paying back the loan if your student can't make payments. If all goes well, both the student and cosigner can benefit from the arrangement.