Pros & Cons of Cosigning Student Loans
What are the implications of cosigning student loans?
It is not that easy for students to fund their education without resorting to loans. Student loans have proved to be one of the key sources of funds for students who aspire to further their education into Colleges and Universities. The cost of tuition fees is becoming increasingly un-affordable for families with average income. So, when parents cannot afford to pay for their young adults school fees, they may look for alternative ways of ensuring that they still play their parental roles to their children.
One of the popular ways parents do help their young children attain their academic goals is by cosigning their student loans. Ordinarily, there should be nothing wrong with this. If a parent cannot cosign student loans for his children, then who will do it for them? However, the fact that you are a parent does not mean that you will be able to cosign student loans for your children. Before you can do this, you will need to have good credit rating. The lender cannot allow somebody with bad credit to cosign student loans or other loans for another person. The essence of cosigning loan is that, the person that is taking the loan may not meet all the criteria that will make him qualify for the loan. Before the loan can be granted, such person will need to leverage on the creditworthiness of another person who will be willing to stand in for him in case he is unable to pay back the student loan. This is common with private loans. The eligibility requirements for federal student loans are more flexible. They are not as rigid as that of private loans. That is why it is better for students to first explore all available federal student loans before they start seeking for private student loans.
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Before you cosign any student loans, it is important that you fully understand what you are going into and its implications to your personal finance. Therefore, we shall discuss the advantages and disadvantages of cosigning student loans below:
Pros of Consigning Student Loans
The main advantages of cosigning student loans are:
- Helps securing loan: In most cases, students don’t have what it takes to get private loans. For instance, students may not have collateral to pledge as security for their student loans. Also, some of them may not even have credit history which the lenders can use to measure their creditworthiness. For these reasons, it is practically difficult for them to get student loans on their own without involving another person who will be ready to cosign their loans. The cosigner does not necessarily need to be their parents. He can be a relative or any person whose trust they have earned over time. The most important thing is that the person should have good credit and should be willing to pay back the student loan in case the borrower default. By cosigning the student loan, the student will be able to get the loan. This will help him achieve his career objective. If he is successful, he will be eternally grateful to you. Who knows whether he may turn out to be somebody who will support you in the future if the needs arise. As they say, one good turns deserve another.
- Large loan amount: Cosigning student loans goes beyond just helping the student to get the loan; the student can be granted large amount that will be enough to pay for his tuition fees. Even, if a student meets the Federal student loans requirements, the amount he will receive may not be adequate for him to complete his education. It is actually more difficult for students to get additional loans from private lending institutions when they have already accumulated some federal student loans. But by getting their loans cosigned, there is possibility that the amount being required from the private lenders will be granted.
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- Better interest rate: In determining the interest rates that will be charged on a particular loan, private lenders usually assess the creditworthiness of the individual loan applicants. How do they assess the creditworthiness of borrowers? Lenders rely so much on the credit score of individuals as indicative of their creditworthiness. The credit score is arrived at by credit bureau agencies using certain criteria. For instance, the criteria that FICO uses in calculating credit score include payment history, credit utilization, length of credit history, new credit and credit mix. It is believed that borrowers with good credit rating are creditworthy and will likely pay back their loans, both the principal and interest thereon, as at when due. This make them enjoy good interest rates. On the other hand, people with not-so-good or bad credit score might have had history of late or missed payments. Since history usually repeats itself, there is tendency for them to miss their payments again if they are granted new loans. For this reason, their applications for loans may either be declined or at best, they get the loans at very high rates. Although some students may not have history of late or missed payments, the problem is that most of them don’t even have any credit history. This makes it difficult for lenders to be able to assess their credit risks. That is why students may likely be charged very high interest rates when applying for private student loans. But if they have someone with very good credit score to cosign their student loans, this will make the lenders to lower the interest rates on their student loans. Since the responsibility for the repayment of the student loan rest on the person that cosigns the loan, it is as good as if it is the cosigner that is getting the loan.
- Attainment of dream: Cosigning student loans is a way of helping the student attained his career goals. Many people would not have been able to further their education if not for the availability of student loans. That is why some parents see cosigning of their children’s student loans as a way of helping them fulfil their dream. Besides, some parents take pride in seeing their children become professionals. Therefore, they are ready to do anything in their capacity to have that dream fulfilled. At times, cosigning student loans by the parent may not just be about the student. The parent may be doing it for his personal ego and ambition. He may want to be proud to see his children becoming professions. Such parents may believe that by the time their children graduate as accountants, doctors and engineers, they won’t have problems paying back their loans. Well, that is a good dream anyway!
- Credit building: I mentioned earlier that many student don’t have credit history at all. Cosigning student loans for them is a good way of helping them to start building their own credit. As long as the student doesn’t miss or make late payments, he will be able to build his credit gradually. Also, this also help the cosigner as the credit will be on his credit report.
Cons of Consigning Student Loans
Cosigning student loans may not be a bad thing to do on its own but for the inability of many students to keep to the terms of the loans, one may need to think twice before consigning a loan for any of them. This may sound very blunt but that is just the truth. Before you cosign a loan, I will like you to consider the following disadvantages of such practice.
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- Impact on credit history: Firstly, you need to understand that if you cosign any loan, the loan will be recorded in your credit report. In the same manner, all the payments on the loans will reflect on your credit report. Therefore, if the student you cosigned a loan for misses or makes late payments, it will definitely have negative impacts on your credit history. And this will affect your credit score too. However, if the student is able to make timely payments thereafter, the impacts of the late payment on your credit score will soon fade away. If you know that just a few drop in your credit score will alter your credit rating, cosigning student loans may not be helpful except you are very sure that the person will not miss or make late payments.
- Inability to get new loan: Some people think that as long as the student is paying back his loans, cosigning student loans cannot cause any issue. This is not absolutely true. When you cosign a student loan, your credit length will be altered. Also, your income to debt ratio, which many lenders will usually consider before granting loans may increase significantly. This may disqualify you from getting new loan. If the loan is granted you, it may be at a very high interest rate. So, if you are planning to apply for mortgage loan very soon, cosigning student loans may not be appropriate at this time.
- Strained relationship: This is the bad side of cosigning student loans. People cosign loans based on trust. The cosigner will believe that the borrower will not disappoint him. Unfortunately, events may turn out to be the opposite. What happens when the person you cosigned a loan for couldn’t pay it back based on the terms of the loans? In some cases, the borrower may not have the mind of disappointing you. But anything can happen which may make it impossible for him to meet his obligations. It may happen that he can’t get a job that pays well after he graduated. He can even lose his job. In such instances, there is little he can do to salvage the situation. It is like saying that the spirit is willing but the flesh is weak. This can lead to a strained relationship. If you know you will not be able to manage such situations, it may be good to decline cosigning student loans. This may not be an easy thing to do at the moment but you will be able to preserve the relationship. The student may not understand you now but later he will realize the reasons for action.
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- Difficulty in getting out of the loan: In some cases, it can be difficult for the cosigner to get out of the loan. It is not something that you do today and you then say you are changing your mind tomorrow. Cosigning student loans is ‘for better for worse’ kind of relationship. Therefore, you need to think it through before you make yourself available as a cosigner.
- Financial risk: When you cosign a loan, you are actually putting your finance at a risk. The responsibility for paying back the loan is on you. This means that, if the student defaults, the lender will be on your neck to pay back the loan. Even if the borrower dies, you may still need to pay back the loan. So, if you know that your finance cannot support paying back the loan you want to cosign, it may be too risky cosigning such loan.