Whether you’re the parent, aunt, or friend of a student who is planning to pursue a higher education, chances are that the student will need a cosigner to be approved for a private student loan.
Students usually don’t have long enough credit histories in order to be deemed reliable borrowers. So, most private student lenders will require borrowers to have a cosigner as a form of insurance that the loan will be paid back in full.
Cosigning on a student loan is a big deal – not only can it have an impact on the student’s credit score, but it can also impact yours as well.
In this article, we’ll tell you what you need to know to make an informed decision when cosigning a student loan.
What is a Private Student Loan Cosigner?
A cosigner is an individual who “signs” the student loan with the borrower, becoming contractually obligated to pay off the loan or any missed payments if the student is unable to do so. This means that whatever payments the student borrower cannot make, you must take responsibility for. Cosigners are usually parents, extended family members, or close friends, though anyone can cosign for a private student loan.
What Are the Requirements for a Cosigner?
Cosigners must be a minimum of 18 years old, be a U.S. citizen, and have cosigned the student loan without coercion, manipulation, or force.
Principally, it is ideal for the cosigner to have an excellent credit score and a steady income to improve the primary borrower’s chances of qualifying for the private student loan. This is because a cosigner who demonstrates creditworthiness, or the reliability to pay off payments on time, increases the chances for the student loan being approved.
Pros and Cons of Cosigning a Student Loan
It’s important to preface this conversation by saying that you should only consider cosigning a private student loan after you’ve exhausted all other options.
Whether it be scholarships, grants, federal student aid, or federal loan options, be sure that you know what options are available (or not) to the student on the market.
Pros
You Can Help the Borrower Get Approved
Only 8% of students get approved for private student loans without a cosigner. So, without a cosigner, the chances are incredibly slim that the student borrower will get approved for the private student loan on their own. In the case that the private loan is even approved, the student will most likely have unfavorable interest rates and inflexible repayment options.
On the other hand, having a cosigner improves the chances of the student being approved for a private loan with adequate terms. Having a cosigner adds an additional amount of security for private lenders, as the chances of the loan being paid back in full increases with two signers.
Some private student loans require a cosigner when issuing loans, while others highly recommend the option.- You Can Help the Borrower Get a Lower Interest Rate
With or without a cosigner, student borrowers still need a way to pay for their education costs, so they end up signing private loans with disadvantageous terms (higher interest rates, shorter repayment periods, limited loan options). This often results in student borrowers racking up overwhelming amounts of education debt (hence the student debt crisis in the United States). Currently, over 3 million people in the United States have more than $100,000 in student debt.
Cosigning for a private student loan can help your student land a private loan with lower interest rates, more so if you have a strong credit history. This will help the borrower save money in the long run.
- You Can Help the Borrower Build Credit
Cosigning a student loan can allow a borrower to get approved more easily. Once the student borrower is approved for the private student loan, the borrower can begin to build their credit history as they make payments for the loan. The lender reports the student borrower’s payment activity to major credit bureaus, and this information is utilized to calculate a portion of the student’s credit score.
Payment history makes up 35% of the student borrower’s FICO score, a numerical score that assesses their credit based on five components. Payment history is how well you’ve paid for your lines of credit over time, and if the student stays on top of the payments, their credit score can improve.
This couldn't be possible without having a cosigner on the loan, and paying off student loans is a great way for students to start building their credit history.
Cons
Your Debt-to-Income Ratio Can Be Impacted
Your debt-to-income ratio is one way that lenders measure your creditworthiness, which is your reliability to pay back a loan on time.
What is a Debt-to-Income Ratio?
Your debt-to-income (DTI) ratio is the ratio between your monthly debt expenses (payments that show up on your credit report) and your monthly gross income (this is an odd way to say pre-tax income). In order to calculate your DTI, you divide your monthly debt expenses by your monthly pre-tax income, and your DTI ratio will be in the form of a percentage. The lower the DTI ratio, the better (this makes mathematical sense because your monthly debt expenses make up a smaller percentage of your income).
Within debt-to-income ratios, there are front-end ratios and back-end ratios. The front-end ratio is also called the housing ratio. It calculates what percentage of your monthly pre-tax income goes to all housing-related debt payments, like homeowner association fees, rent, mortgages, homeowners insurance, etc.
The back-end ratio calculates what percentage of your monthly pre-tax income goes to all of your monthly debt payments, meaning housing-related debt payments + payments like credit card bills, auto loans, student loans, etc.
For example, let’s say your monthly debt expenses consist of the following:
Car payment: $200
Homeowners Association fees: $300
Credit card payments: $542
Student loan payment: $321
Hospital bill: $120
This adds up to a total of $1,483 of monthly payments. Let’s say your monthly pre-tax income is $6,249.
What is a Good Debt-to-Income Ratio?
A good DTI ratio is lower than 36% for the back-end ratio (which measures what percentage of all your monthly debt payments make up of your monthly pre-tax income) and no more than 28% for the front-end ratio (which measures what percentage of only your housing expenses make up your monthly pre-tax income).
The DTI ratio for the example above would be 23% because $1,483 divided by $6,249 is .23. This is an excellent DTI ratio as it is lower than 28% overall.- Does Cosigning for a Student Loan Affect Your Debt-To-Income Ratio?
Yes, cosigning for a student loan will impact your debt-to-income ratio. If you cosign for a student loan and are approved, the amount of the loan is added to the back-end ratio of your debt-to-income ratio and to your credit report. This means that your DTI will increase.
Take this fact into consideration before you cosign for a student loan and do the calculations beforehand.
If your DTI ratio goes beyond 36% when you factor in the private student loan, it is probably best for you to not cosign the student loan. Having a DTI ratio that is higher than the ideal ratio can harm your likelihood of being approved for favorable mortgages, auto loans, and new lines of credit. However, if cosigning the borrower’s student loan is the only way they can get approved, then you will need to weigh the pros and cons and determine if it is worth it for you individually.
That said, if your DTI ratio safely remains under the threshold, you do not need to worry.
- The Loan is Technically Your Responsibility
If you cosign for a student loan, any amount that the student borrower does not pay falls into your hands. You are legally obligated to pay any missed payments or even the full amount of the loan if the student borrower does not.
- It Could Hurt Your Credit
While being a cosigner in itself does not hurt your credit score, your credit score will be negatively impacted if the primary student borrower misses any payments. Not only will it negatively impact your credit score, but any missed or late payments will also show up on your credit report (and cannot be removed for seven years).
Whether you are financially challenged or comfortable, there is no margin for error for the student borrower when cosigning a student loan. Any missed or late payments will become your responsibility and can even put a strain on your current bills.
- It Could Strain Your Relationship with the Borrower
Student loans can get messy, fast.
For one thing, the student will be financially linked with you until the entire loan is paid off, unless there is a cosigner release policy. If there isn’t, it could be quite a bit of time until you are off the hook in regards to the loan.
Even worse, if the student defaults on the private student loan or is late/completely misses a payment, these actions will have severe implications for the both of you.
Be sure to cosign a student loan with someone that you know to be trustworthy and responsible. Cosigning a student loan isn’t a lighthearted decision, and you need to know what you’re getting into before you sign anything.
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How Long Does a Cosigner Have to Stay On a Student Loan?
Be sure to consider cosigner release terms before cosigning a student loan. While some student loans do not have any cosigner release options and the cosigner remains linked with the student loan until it is completely paid off, other student loans have cosigner release options.
Cosigner release, as the name implies, releases the cosigner from a loan if the student borrower makes a certain number of payments on time and also meets the credit requirements.
If cosigner release is not an option, consider refinancing the student loan. Refinancing is when you can trade in your current loan for a more favorable one with lower interest rates, longer repayment plans, etc. If the primary borrower, the student, refinances the student loan under their name, you are no longer contractually linked to the student loan. This is only an option if the student has a strong credit history.
Is It a Good Idea to Cosign for a Student Loan?
Cosigning is common in the United States. In fact, 91% of undergraduate student loans have a cosigner. However, the decision is ultimately up to you. It is crucial to consider the pros and cons before agreeing to cosign for a student loan.
Before you cosign for a student loan, make sure you have a serious discussion with the student. Outline what you expect from the student, whether it be a minimum GPA, expectations for graduation, and repayment responsibilities.
It’s crucial for you and the student borrower to both know what is expected of one another.
Closing Thoughts From the Nest
Non-cosigned loans are a great option to explore if cosigning does not seem like a plausible option for you.
Sparrow offers services that can help you and the student explore private student loan options. By submitting a free form with us, you can see which student loans the student can pre-qualify for on their own (and the lowest interest rate on the market) and also compare loan options with alternative cosigners. Most loans do not offer this precheck, so be sure to take advantage of this tool.