The Role Of Parents In Co-signing Student Loans – With the cost of college rising faster than inflation, the amount of money parents have to borrow for college is also rising. Once they exhaust federal loans (capped at $5,500-$7,500 per year), some students turn to private loans.
These loans can bridge the gap between a financial aid package and the amount a family currently has for college, but they come with a serious catch: They often require co-signers. This may seem like a no-brainer for parents who want to help their children move forward with co-signing a loan to participate in Dream U. A 2012 report by the Consumer Financial Protection Bureau found that more than 90 percent of private student loans require a co-signer, typically a parent or co-parent.
The Role Of Parents In Co-signing Student Loans
Although less than 10 percent of families borrowing for college use private student loans, those who borrowed an average of more than $12,000 last year more than doubled the amount they borrowed in 2011, according to Salle Mae’s How America Pays for College report.
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Co-signing student loans for your children, however, can have long-lasting effects on your financial security. “Parents just want to help their kids pay for college, but sometimes they don’t realize the financial consequences of doing so,” says Fred Amarin, principal of Amarin Financial in Wynwood, Pa.
You are on the hook. Co-signing a loan means you are fully responsible for the entire loan – it will show up on your credit report. If the junior can’t or won’t pay for some reason, the lender will go after you for payment. If you can’t afford to make the payments, or if taking out the loan would ruin your ability to get the mortgage or car loan you need, co-signing a loan may not be the best way for your family to borrow money.
While some private loans allow “cosigner” programs, in which a co-signer can be removed from the loan once the primary borrower meets certain income limits and makes regular payments, a CFPB report found that 90 percent of consumers who applied for such a release were denied.
Go with Federal Loans First Before looking at private student loans, students should maximize any available federal loans that have lower interest rates, offer more flexible repayment terms, and don’t require a co-signer. Even if you don’t think your family will qualify for financial aid, you still need to file a Federal Application for Student Aid to qualify for a federal loan.
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Some families also use Parent PLUS loans to pay for college, which are federal loans in a parent’s name that have many of the same consumer protections as federal student loans. Even if you plan for your child to pay these debts, she is under no legal obligation to do so. The impact on your credit score and debt-to-income ratio is the same as co-signing a loan.
Don’t borrow more than you can afford. Once you’ve exhausted that and are considering private loans, parents should limit their total college debt for all children to no more than one year’s income or what they can pay off in 10 years or before they retire, whichever comes first.
Consider your child’s projected income and make smart choices about whether he can cover the payments. Students should aim to borrow more than their expected first-year salary. “If a student wants to borrow more than that, you need to look at another school,” says Kal Chaney, author of Paying for College Without Going Broke.
Before you take out a loan, find out if the lender will release you from the loan in case of your child’s death. If not, you should take out life insurance for your child to protect you from the financial impact of such an event.
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Have a repayment plan. Use the loan payment calculator from FinAid to determine the monthly payment on a loan and shop around for the best deal. Then sit down with the student and create a mock budget that explains how it might affect their ability to do other things right after graduation, like moving out or traveling with friends.
Discuss who will be responsible for paying back the loan before you co-sign, and be prepared for difficult conversations and choices if he or she can’t make the payments. Unlike federal loans, most private loans do not have a grace period after graduation. So if your child doesn’t land a job right away or takes an unpaid internship, you’ll need to be prepared to make the first few payments.
Kathy Ruby, a college finance expert with admissions consulting College Coach, advises students and parents to set up a joint “buffer account,” in which the student contributes cash, which the loan company automatically debits from the account. (You can even get a small break on the rate for signing up for an automatic payment program.) Then you can set up alerts to monitor the account to make sure there’s enough cash to cover upcoming payments, and contribute some cash of your own if necessary so you don’t miss out. Payments will not damage your payment.
If your graduate wants to make additional payments on his loans, focus on paying off private loans first. This will clear your loan liability quickly and reduce the total interest paid on it.
Cosigning A Student Loan Risky For Parents
Beth Braverman Contributing Editor Beth Braverman covers all aspects of personal finance. Formerly a senior reporter at Money magazine, she was also a newspaper reporter and trade magazine editor. One question is bound to come up as college students walk onto campus: “Hey, Mom, would you cosign for a student loan?”
And often that knee-jerk reaction is “Sure, why not?” Parents and grandparents feel that when it comes to getting a college diploma, they should help out and contribute to all the college debt.
“There’s no boxed warning label that says co-signing a student loan can be dangerous to your wealth,” said Mark Kantrowitz, college loan expert and senior vice president and publisher of Edvisors.com.
“On this loan, you’re giving them the keys to your car,” Kantrowitz said. “You’re giving them the ability to ruin your credit.”
Do You Need A Co Signer For Student Loans?
For a student, having a cosigner increases the chances of getting approved for a private student loan. The borrower will generally qualify for a lower rate. Loan rates on private student loans vary based on credit history.
But cosigning isn’t as simple as referencing. This means the parent or grandparent is on the hook if the student defaults. Cosigning puts your credit score at risk if the student makes late payments or falls behind.
We all have a lot of faith in our children, but they won’t get a job or finish college right away.
Katie Moore, a financial advisor at GreenPath Debt Solutions in Detroit, said that sometimes students take on so much debt that they really can’t afford to pay it back. She met an aunt who had taken out a loan for the niece and was no longer in touch with the student. She had no idea that student loans were not being paid off.
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The aunt now has to deal with the burden of those student loans, along with her own financial struggles after being laid off. Another point: Student loan debt generally cannot be discharged in bankruptcy.
Kantrowitz noted that parents who take out student loans can face even more obstacles down the road if those parents later want to refinance the mortgage or take out a loan to buy a new car or truck. That co-signed loan is treated as the parent’s loan.
There are a few things parents — and yes, grandparents — need to consider before signing on for high-cost private student loans:
Federal student loans do not require a cosigner. According to the Consumer Financial Protection Bureau, about 90% of private student loans were cosigned in 2011. That’s up from 67% in 2008.
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Federal Stafford loan rates for undergraduate students will be 4.66% if student loans are taken out between July 1 and June 30, 2015. The federal Stafford loan rate for graduate students will be 6.21%.
Interest rates are fixed for the life of new federal student loans, but as students borrow more each year, they face new loans that may have different rates.
Kantrowitz predicts that the new undergraduate Federal Stafford loan rate could be 5.5% and the graduate Federal Stafford loan rate 7% next academic year.
Federal Grad Plus and Federal Parent Plus loans are 7.21% for loans taken out July 1 through June 30, 2015.
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One potential drawback is that parents with bad credit history may not be able to take out a Parent Plus loan on their own. Expect a credit check.
If you have a bad credit history, you can get a PLUS loan if you get an endorser with a good credit history. But the endorser is the person who agrees to repay the loan
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