Sometimes federal student loans issued to students aren’t enough to pay for college after scholarships, savings, parent contributions, and grants. To fill in the gap, parents may consider borrowing funds in their own name or cosigning a student loan for their student. After all, students more than likely can’t borrow private loans on their own due to their limited credit history and generally limited income.
However, cosigning a loan can also affect your credit history as a parent, and you don’t know what your student will earn after graduation to repay student loans.
To protect yourself and your student’s credit scores and debt levels, here’s what you need to know about co-signing a student loan:
How Cosigning Works on Private Student Loans
A cosigner on a private student loan is a person who agrees to pay off a loan if the other person doesn’t. The cosigner generally has higher income and better credit, which enables the borrower to get approved or get a better interest rate if they were approved for a higher one. Often, you’ll cosign a loan for a child or spouse, but grandparents and other close family members may also consider cosigning a loan for a student.
“In many respects, cosigners are “co-borrowers” because they are equally responsible for the loan,” says Richard Castellano, Sallie Mae spokesperson. Any missed payments are reported to credit bureaus for both the borrower and the cosigner.
How Cosigning Works on Federal Parent PLUS Loans
Federal student loans issued directly to an undergraduate student won’t need another person to cosign the loan. Parent or graduate PLUS loans may need an endorser, the Department of Education’s word for co-signer, if the parent or graduate student is denied because of adverse credit.
Endorsers have all the co-borrower responsibility of a cosigner on private student loans. However, the federal government has more alternatives to endorsers. Dependent students are given higher loan limits on unsubsidized loans if their parents aren’t approved. The Department of Education also offers parents an opportunity to explain extenuating circumstances that caused adverse credit and possibly avoid needing an endorser.
How to Make Sure the Student Pays the Loan Back
The general rule for student borrowing is to not borrow more than one year of the average starting salary for their major, or 10 to 15 percent of their monthly income post graduation. This amount should include both private and student loans.
You won’t know ahead of time exactly what students will make post-graduation. But you can get an idea by using Edmit’s software, payscale.com, or college career office information. If a student is unsure of their potential major, look up salaries for jobs among their possible choices. Pick the lowest amount as a safety number for helping them figure out how much debt to take on.
If you cosign a loan for a student, don’t expect them to pay back more than that number you researched for the maximum debt load based on potential future income. That way you know how much you will be paying for out of your pocket - now and from loan payments in the future.
How to Take Steps to Protect Yourself
While you do your research and prepare to cosign, take some steps to protect yourself.
- Read the entire promissory note of the loan. You’ll want to fully understand what circumstances trigger a loan default and if there is any flexibility in payment plan options.
- Next, ask if the loan comes with a death or disability discharge for the main borrower. Without this clause, if the main borrower becomes disabled and can’t pay, or the borrower dies, the cosigner may still be responsible for paying the loan.
- If the loan doesn’t have a death or disability discharge clause, you may want to get a life insurance policy on the borrower for the amount of the loan in case you have to pay it off yourself.
How Cosigner Release Options Work
For private student loans, cosigner release is an option for the borrower to remove the cosigner from the loan after proving their own ability to repay the loan. Proving the ability to repay the loan generally means making 12 to 24 on-time payments and showing you have the income to repay the loan yourself. (Note: this is another reason it is important to ensure the amount borrowed is responsible in the context of what the student will make after college!)
For parent PLUS loans, the release process is a bit different. The parent can consolidate their loans to release the endorser from responsibility for the loan. Consolidation is when you take multiple loans and combine them into one. Parents should consolidate all their parent PLUS loans together. But they should leave out student loans issued in their name from when they were students; this protects the extra payment options available on federal loans issued directly to students.
The 5 Most Important Takeaways:
- Cosigners are co-borrowers. When you co-sign a loan, you are equally responsible for payments.
- The student loan payment record is reported to credit bureaus for both the co-signer and the borrower.
- For private student loans, a cosigner release may be possible with 12 to 24 months of on-time payments and proving post-graduation income.
- Don’t cosign for a loan you can’t payback for the sake of your own credit. For the sake of your finances, don’t borrow more than the student can pay based on projected income.
- The endorser on a parent PLUS loan can be released when the parent consolidates their loans, most likely after the student graduates.