This week’s post is written by Jacob at Dollar Diligence. If you are a parent planning to send your child(ren) off to college soon, you might be wondering how in the world you are going to pay for it. One option is cosigning a student loan. As Jacob shares, this might not always be the best idea.
Earning a college degree is less of a choice for younger generations than it was decades ago. Most employers require some level of college course completion before considering offering someone a job, and to continue moving up the rungs of the career ladder, higher education is key. However, the cost of securing an undergraduate or graduate level degree is continuing to climb each year.
Students and parents alike struggle with how to pay without completely draining savings or working a part-time job just to pay for tuition. For most, taking on student debt is a necessary aspect of funding a degree.
When student loans are a must-have in order for a student to finish his or her college career, parents may feel obligated to help by way of cosigning on a new loan. Having a cosigner on a private student loan gives the lender greater peace of mind that the balance will be repaid over time – whether that comes from the student or the parent’s wallet, the lender does not care.
Jumping at the opportunity to cosign a private student loan for your child isn’t always the soundest financial move. Here are few reasons why you should think twice before signing on the dotted line.
You’re on the Hook
The Consumer Financial Protection Bureau estimates that nearly 90% of all recently approved private student loans are cosigned by the student’s parent. The need to have a cosigner arises because younger borrowers do not often have the credit history, score, or income to qualify for a loan on their own. Instead, a parent is tapped to strengthen the application, but that isn’t the only thing taking place.
Parents who cosign on a private student loan are responsible for the monthly payments should the primary borrower, the student, default. The agreement to cosign is a long-term, risky financial obligation that can plague an otherwise well-thought-out plan, even if you’re certain your student is responsible enough to repay the loan in full. If a student loses a job, unintentionally, or they get sick or injured and have no way to earn an income, that private student loan lender is coming to you for payment with no questions asked.
The Student Loan Default Rate
Most parents feel comfortable that their child isn’t going to run off and leave them with a massive student loan bill to repay, but that scenario plays out more often than most imagine. The default rate for student loans has fallen in recent years according to the Department of Education, which should be good news for students, parents, and lenders alike.
Unfortunately, the 11.3% rate of default is still a clear indicator that not repaying student debt is a common occurrence among borrowers. Lower wages, a stagnant job market, and loan balances that exceed five figures don’t help in keeping the default rate low.
For private student loans, the rate of default is often higher because private student loan lenders do not afford borrowers the same protections as federal student loans. For instance, there is not often an option to delay repayment, known as forbearance, when financial hardships occur. If the student cannot pay, the responsibility moves to the parent cosigner. And if there is no plan for repayment from the cosigner’s coffers, the loan could end up in default.
Failing to make timely repayment of a student loan can result in a slew of negative consequences, for the student and the parent. A hit to credit scores, an account in collections, and legal actions taken by the student loan lender are all but inevitable when you default on a student loan. Additionally, other financial aid alternatives from the government offer more protections in default in addition to not requiring a cosigner.
Delaying your Wealth Accumulation
Cosigning on a student loan has the largest impact on the parents’ ability to continue building wealth for their future. When a student has a difficult time getting a job out of college, fails to finish a degree program, or doesn’t earn enough to repay the loans in full each month, parents may be shelling out hundreds to thousands in student loan payments to ensure default does not take place.
Those are dollars that cannot be put toward building a healthy retirement nest egg, paying down credit card or mortgage debt, or contributing to other near-term financial goals that should take precedence. Cosigning on a student loan often means delaying your own financial wants and needs, until your child can manage monthly payments on their own or you are granted a release as the cosigner.
It may seem as though cosigning on a student loan is the right thing to do to help your child get the education he or she needs to succeed in life. However, it is necessary to think twice about the impact that action has on your financial situation both now and well into the future. As a general rule of thumb, students should first go through the motions with federal student aid, namely federal student loans, that require no cosigner before trying to cover their expenses with private student loans.
As a math teacher by day and personal blogger by night, Jacob is constantly looking at and analyzing numbers. He shares some of his best tips and tricks @DollarDiligence.