An unusual feature of federal student loans is that most loans taken out by undergraduates are made without any underwriting, an evaluation performed by private lenders to assess the borrower’s ability to repay.
Students can borrow tens of thousands of dollars from the government to attend college at below market interest rates, even if they’ve never held a job and don’t have the kind of credit history or earnings that private lenders would expect to see.
But there are annual and lifetime limits on how much of the heavily discounted federal student loan debt students can take on. Once they’ve hit those limits they’ll need to turn to more expensive federal PLUS loans or private lenders to meet any funding gaps.
In many cases, students will lack the credit history or earnings needed to be approved for private loans unless they have a cosigner. In other cases, they may get approved for a private loan, but adding a cosigner can help them obtain a better rate.
In some situations, graduate students and parents seeking to take out federal PLUS loans may also need a cosigner — the government’s term is an “endorser.” You won’t qualify for a PLUS loan without a cosigner if you have “adverse credit history,” such as bills that are more than 90 days late, or a bankruptcy or foreclosure within the last 5 years.
Cosigning a student loan for a child, relative, or friend can help them realize their dream of earning a college or graduate degree. But when you cosign a loan, you are essentially taking on all of the obligations of the borrower to repay the loan if they cannot — sometimes without all the rights enjoyed by the borrower.
The good news is, you won’t necessarily be taking on those obligations forever — many lenders will release the cosigner after the borrower has established a track record of making payments.
Here’s a deeper dive into issues and pitfalls that both borrowers and cosigners should keep in mind.
Private Loans vs. Federal PLUS Loans
Private loans are usually a final recourse for students who have exhausted all of the grants, scholarships, and state, federal and school-based financial aid they’re entitled to. A private loan should not be taken on lightly, but can sometimes benefit students who have gaps in financial aid or need some extra money to complete their education.
Federal Loan Limits & Interest Rates
Undergraduates who are dependents of their parents can take out a total of $31,000 in subsidized and unsubsidized direct federal student loans. Students who are not dependent on their parents, or whose parents aren’t eligible to take out PLUS loans on their behalf, can take out up to $57,500 in federal direct loans as undergraduates.
These direct federal student loans for undergraduates are the best deal the government offers — rates on new direct loans to undergraduates issued after July 1, 2016 will be 3.76%.
For students moving on to graduate school, rates on direct unsubsidized loans are significantly higher — they’ll be 5.31% for new loans issued after July 1, 2016.
The aggregate borrowing limit for federal direct subsidized and unsubsidized loans for graduate and professional students is $138,500.
For students who need to cover additional expenses at either the undergraduate or graduate level, the government also offers PLUS loans to parents and graduate students. You can take out all of the PLUS loans you need to pay for school attendance costs that aren’t covered by other financial assistance you’ve received.
But you’ll pay a lot more interest on PLUS loans — rates on loans issued from July 1, 2016 through June 30, 2017 will be 6.31%. Another drawback of PLUS loans is that they carry a hefty 4.3% up-front disbursement fee.
This is where private student loans can start to look attractive. A number of private lenders — including Citizens Bank, CollegeAve, RISLA, Sallie Mae, SoFi and Wells Fargo — offer student loans and education loans for parents that are priced competitively with federal PLUS loans.
Citizens Bank, for example, offers student loans for parents with 10-year fixed interest rates as low as 6.29% with no application, origination or disbursement fees.
Private lenders also offer student loans directly to students. Because most students don’t have the kind of credit history or earnings to qualify for a sizeable loan, private loans made directly to students almost always involve a cosigner.
According to MeasureOne, an aggregator of private student loan data provided by six major lenders, almost 94% of private undergraduate student loans have cosigners.
Pros and Cons of Cosigning
Why cosign a loan for a student, rather than taking out a parent loan to pay for the same student’s education? One reason is that it will be clear who is expected to repay the loan — the student. Both the borrower and cosigner will understand that the cosigner will only be expected to repay the loan as a last resort.
Cosigning a private student loan or endorsing a federal PLUS loan can help a son, daughter, friend or relative close funding gaps on their path to a degree. A cosigner can also help these borrowers obtain a lower interest rate from private lenders, potentially saving thousands of dollars in interest payments.
When you cosign a loan, you’re letting a borrower use your good name and credit standing to their advantage. But just as you put your name and credit score on the line when you take out a loan in your own name, you run similar risks when cosigning a loan.
The debt will show up on your history if you need to borrow in the future, and if the student you have cosigned for does not make timely payments it could affect your credit score.
Endorsing a Federal PLUS Loan
When you endorse a federal PLUS loan, you’re pledging to repay the full amount of the debt, including unpaid principal, accrued interest, late fees, or collection costs if the borrower fails to repay.
If you get stuck with repaying the loan and you miss payments, collection methods can be used against you — including garnishment of wages. If a federal PLUS loan goes into default, that will be part of your credit history.
While borrowers of federal PLUS loans can apply for a deferment of up to 3 years during periods of economic hardship, endorsers don’t enjoy that right. Endorsers can request forbearance for up to 12 months in the event of financial hardship or illness, but interest will continue to accrue on the loan.
If you end up being the one who has to repay a federal PLUS loan, you cannot apply to combine them into a federal Direct Consolidation Loan, which borrowers can use to simplify their monthly payments or stretch them out over time.
Cosigning a Private Student Loan
When you cosign a private student loan, many lenders will allow the borrower to apply to have you released from your obligations once they’ve made a certain number of on-time payments, or otherwise established their creditworthiness as a borrower.
Citizens Bank, for example, will allow borrowers to apply for cosigner release after they’ve made 36 consecutive on-time payments of principal and interest — after three years, in other words. The clock gets reset if the borrower enters deferment or forbearance, and borrowers must meet certain credit and eligibility guidelines when applying.
Another private student lender, College Ave, will accept applications for cosigner release after the borrower has made 24 consecutive payments, and can provide proof that they’ve been working for the last 12 months and have annual income that’s at least twice the sum of all loans outstanding with College Ave.
How easy is it to obtain a release?
When the government’s consumer watchdog, the Consumer Financial Protection Bureau, looked at cosigner releases in a 2015 report, it questioned whether some lenders were providing enough information about the specific criteria needed to obtain one. Nine out of ten borrowers who applied for cosigner releases were rejected, the report said.
While lenders often require that borrowers demonstrate their own creditworthiness before releasing a cosigner, the policies provided to borrowers typically don’t spell out a specific credit threshold to qualify.
“The low number of successful cosigner release applications suggests that the lack of transparency about eligibility criteria may be a significant factor,” in the high rate of rejection, the report said.
Some lenders permanently disqualify borrowers from obtaining a cosigner release if they’ve accepted an offer of forbearance, the report noted. The Consumer Financial Protection Bureau recommended that lenders make such implications clear when extending offers of forbearance.
Borrowers may find out that having a cosigner can lead to unwelcome surprises. Borrowers may be denied a loan application when they run into financial problems based on the lender’s determination that the cosigner is able to make payments.
The report was also critical of “surprises buried in the fine print” of private student loan contracts, such as auto-default clauses that allow lenders to put borrowers who are paying back their loans in default if a cosigner dies or files for bankruptcy.
Some loans are also packaged with “universal default” clauses that allows the lender to trigger a default if the borrower or their cosigner gets behind on another, unrelated loan with the same institution, such as a mortgage or auto loan.
Other problems can arise when the same borrower has loans cosigned by different people. If the borrower gets behind, cosigners may have to double check that the payments they are making are credited only to the loan or loans that they have cosigned for. Otherwise, loan servicers may allocate their payment proportionally across all loans.
Even if the borrower you’ve cosigned for makes their payments, the obligation you take when you cosign a student loan could affect your own credit, making it more difficult to refinance your mortgage at a lower rate, for example.
Once students have taken out all of the federal direct loans they are eligible for, rates on private student loans can be quite competitive with federal PLUS loans. There are a number of private lenders competing for your business, so it pays to shop around.
The Choice is Yours
Make sure you discuss financial options with your student so they’re clear on how their education is being paid for and what the expectations are. Many students end up being unaware of how much debt they have taken on and what their minimum payments will be. As a cosigner, you’ll want to make sure your student knows what their responsibilities are.
Although there are some risks involved, putting your name down as cosigner means your student can take advantage of the best rates available. Do your research, compare offers from multiple lenders, and be sure you’re getting the best deal you can!
- Endorser Addendum to Federal PLUS Loan Application and Promissory Note
- Mid-year update on student loan complaits. Consumer Financial Protection Bureau