With the rising costs of higher education, most college students turn to private student loans to pay their tuition. However, most young adults will have difficulty qualifying for this type of loan on their own due to a lack of credit history and stable income sources.
That’s why more often than not, undergraduate private student loans are co-signed by parents to fill tuition gaps left after grants, scholarships, and federal student loans have been maximized.
Every parent wants to provide the best education possible for their child, and co-signing their student loan is one way to do exactly that. However, this decision should be thought through ten times over because once you commit, you’re legally bound to pay your child’s debt if they’re unable to fulfill their obligation.
In this guide, we’ll take a closer look at the factors you must take into account before co-signing your teen’s student loan. We’ll also outline the top tips to keep in mind once you’ve decided to share the responsibility with your kid.
Things to Consider Before Co-signing Your Teen’s Student Loans
Co-signing a student loan is not as simple as giving a reference; it’s committing to being a co-borrower equally responsible for repaying the debt. So when things go awry, you can face disastrous and possibly permanent financial consequences.
Consider these first before co-signing your child’s private student loan:
Your Financial Status and Credit Score
Private student loans will use your financial history, including your credit score, to determine a borrower’s eligibility and what interest rates to offer. Top lenders often require a credit score of at least 600.
When you co-sign your teen’s student loan, the lender will offer terms based on your credit score. So if you have a steady income, good credit standing, and a low debt-to-income ratio, then there is a huge chance that your child will secure a favorable loan (i.e., lower interest rates). Otherwise, you should identify areas bringing your credit score down and work towards improving it.
Your payment history largely influences your credit score. So if your teen consistently misses payments on their loans or goes into default, it will also appear on your credit report, causing your credit score to take a serious hit. Even a single late payment can negatively impact this number.
Your Ability to Repay Your Teen’s Student Loan if They Can’t
Before co-signing a student loan, you should assess your willingness and ability to repay the loan in the event that your teen can’t pay them back on time or at all. As a co-signer, you are the loan provider’s “insurance policy,” i.e., the party ensuring their investment will be repaid if the primary borrower can’t.
If taking on your teen’s debt will cause significant money problems, it may not be wise for you to co-sign their student loan. Even if you think that’s unlikely to happen, it’s essential to consider the worst-case scenario when it comes to major financial agreements.
Your Need to Take Out Another Loan in the Future
If you foresee taking out other types of loans in the near future, whether for a second mortgage, auto loan, or personal loan i.e., for a bucket list trip to Italy, then you may need to hold off on co-signing your teen’s student loan.
When you co-sign, your child’s debt will be added to your credit profile, increasing your debt-to-income ratio. As a result, you appear riskier to lenders, lowering your chances of getting approved for other loans. And if your teen often misses payments, it will impact your credit score and make it harder for you to secure a new loan.
Tips When Co-signing Your Teen’s Student Loan
If you’ve considered all the abovementioned factors and decided that co-signing is the right choice, here are a few best practices to remember.
Make Sure You Have Fully Exhausted Other Funding Options
A private student loan should be your last resort among all financial aid options. Before going that route, encourage your teen to apply for scholarships, grants, and work-study programs, or try filling out a Free Application for Federal Student Aid form to receive financial aid.
If none of the above methods gets them the money they need, they should try to apply for federal loans, which are typically cheaper compared to private lenders. Also, the federal government offers more flexible repayment plans and forgiving relief options if the borrower struggles to make timely payments. Moreover, federal loans don’t need a credit check, and most don’t even require a co-signer.
Sit Down With Your Teen and Discuss Debt
Before making the big commitment, sit down with your child and have an open conversation about debt and what it entails. The loan will affect both your credit score and theirs, so certain expectations must be set before you go into the process.
For one, plan out a payment schedule and help your teen create a budget, if necessary. You can also help them set up auto payments for good measure.
As a parent, you should be able to take on a guiding role and help the primary borrower understand the consequences of missing a payment. Discuss what is expected of them and ensure they know the importance of taking their education seriously and being financially responsible.
Take Advantage of Co-signer Release Offers
Many private student loan lenders typically offer co-signer release, which allows you to be freed from a loan you co-signed once the borrower has proven their ability to independently pay it.
Before this perk is granted, the primary borrower must meet specific requirements, which vary per lender. The most common examples are 24 to 36 consecutive on-time payments, proof of income, and credit checks.
So if you plan to seek co-signer release eventually, make sure to look for this detail when comparing lenders and applying for loans because only some lenders offer them.
Consider Refinancing the Loan
Once your teen has established good credit, you can create a well-planned roadmap for refinancing the loan. This will remove you as a co-signer so that the loan will be made to your child directly. Once your teen qualifies for refinancing, help them research loan options available to them.
However, if they don’t have a good enough credit score to qualify for a low-interest rate, refinancing the loan might make it harder to pay it off. So before choosing this route, ensure that your teen makes on-time payments after graduation so they can increase their credit score and help with refinancing.
If you’re considering co-signing a loan, it’s best to think about your financial capability and long-term plans before making such a huge commitment. While it’s impossible to predict the future, it’s good to go into the process with a complete understanding of what it entails so you can limit negative consequences or, at the very least, know all the possible outcomes of your decision.