You did a nice thing for your son or daughter. You cosigned a student loan. Or, maybe you helped out your brother or sister, cosigning an auto loan. You feel good about helping a friend or loved one, and you go on your way. You don’t think much about what you did.
What do you think our reaction is?
“Stop!”, we say. “You missed one important step that could have a damaging effect on your credit and ability to secure lending in the future.”
“What step is that?” You ask.
“You did not ensure protecting yourself in case you OR your borrower can’t pay the loan.”
“Ok.” You roll your eyes. “Sure. Why do I need to do that? The loan company will take care of it if something were to happen.”
You pause. “Right?”, you ask.
What Does Cosigning a Student Loan Mean?
By cosigning a student loan, you are telling the loan servicing company this:
if the borrower dies, becomes disabled, loses his or her job, or just can’t pay, I will assume the payments.
That is the purpose of cosigning – and why loan servicing companies like cosigners. It essentially means the debt is guaranteed.
“By who”, you ask?
If you cosign, you are legally obligated to repay the student loan in full if the borrower fails to pay.
If you have cosigned a loan, chance are you cosigned a student loan. These cosigned loans typically are private loans. (We will use a student loan in our discussion as it is one of the most popular cosigned loans. However, know that the loan can be any loan – auto, credit card, etc.)
With private loans, the loan servicer establishes the terms and conditions. They specify how and when the cosigner is required to pay. You really need to ask questions and review the fine print. Contrast this loan with a federal student loan, which typically do not require a cosigner and generally have more relaxed parameters, particularly when the borrower can’t pay.
Cosigning a loan may sound dour. Peruse the internet, and you will read many websites that tell you to never to cosign a loan. While there is much truth to that, it is because people don’t know what they are getting themselves into. If you understand the risks, and set up a plan in case the borrower can’t pay, cosigning a loan isn’t scary as it sounds. There are still risks, but you have a plan that won’t ruin your good credit and future borrowing capabilities.
5 Things You Need To Do If You Cosigned A Student Loan
Here are 5 things you need to consider if you cosigned a student loan. By understanding these, you will have an educated idea on whether or not you should cosign a student loan.
1 – Know The Details: Your Borrower’s Loan Is Your Loan
When you cosign a student loan, your borrower’s loan (presumably, your child’s) becomes yours. If your child / borrower fails to pay, the onus is on you to pay.
However, it doesn’t stop there. You want to borrow. Or, let’s say you want to refinance a mortgage. Well, you likely can’t. You see, your child / borrower’s loan becomes your loan.
Also, although there’s been a lot of talk of student loan reform, currently student loans are not discharged in bankruptcy court.
Did you know that? If your child / borrower can’t pay the loan, the payment is now your responsibility.
Moreover, your credit score will likely take a (hopefully) small hit as the loan servicing company makes a “hard hit” on your credit. Additionally, the loan will show up on your credit report.
You really need to read the fine print and understand what happens if your child / borrower can’t pay the student loan.
If you don’t understand or don’t feel comfortable, the answer is simple: Don’t sign the loan!
2 – Know Your Child / Borrower
We love our children. We want the best for them, right? Let’s be honest, though. Some kids should not have a loan. They are irresponsible or have no idea about the responsibility of a repaying a student loan. Moreover, they don’t understand how much you’ve put at stake for their success.
We know some children deserve that chance, of course. However, there are some kids who do not. You know in your gut. If your child is careless or irresponsible with money, do not sign the loan.
Feel badly if you decline? You aren’t doing harm, and you should not feel badly. Discuss constructively with your child / borrower the reasons you made your decision. If he or she balks or gets upset, after presented with constructive reasons, you know you made the right decision.
You can look no further than this poor woman…who may end up poor because of her decision.
3 – Require A Credit / Financial Literacy Course Or Meet With A (True) Financial Planner
If we haven’t made it clear yet, you are putting your own credit and future on the line.
It’s not harmful, but wise to tell your child / borrow to attend and fulfill a credit or financial literacy course or even meet with a financial planner. Remember, you are putting yourself at risk. If your child / borrower understands about the severity of what you are doing, there should be no problem.
Moreover, a course of this type will help them beyond just the responsibility of borrowing and repaying a student loan.
You want this course to discuss how to plan a budget, pay back a loan, teach the difference on needs versus wants, etc. Meeting with a financial planner is also good practice. He or she should be an expert with budgeting, teaching your child / borrower about how to repay the loan.
A word of caution. Many financial planners are not skillful with student loan planning. Seek a knowledgeable planner who will teach your child/borrower how to pay back the student loan.
4 – Get Life Insurance On Your Child / Borrower If You’ve Cosigned A Student Loan
When we suggest life insurance as a responsible option, many parents accuse us of trying to “sell” them. That is far from it. It is only responsible (as you can guess the premiums are low).
If you child / borrower were to unexpectedly die (and young adults do die everyday), you are on the hook for the student loan. Unlike Federal student loans, the private student lender does not have to waive the repayment on death. That is why you cosigned. You are now legally obligated to repay the student loan!
Talk about pain and sorrow after pain and sorrow.
Some companies will require you to pay each month while others will require full balance payment! Which one is spelled out in the contract? You need to check. Do you think this is a joke or it can’t happen to you? Follow this link to this unfortunate story; it happens more than you think. (note: after much publicity, the loan company relented and extinguished this young woman’s (and parent’s) student loan debt.
Are you thinking life insurance must be expensive? A $100,000 death benefit, 20 year term with will cost about $8 to $11 per month.
If you are allowing your good credit to be at risk, the borrower needs to be responsible and establish protection on him or herself. It’s only fair; you are putting yourself on the line and he or she needs to do the same. If not, then don’t cosign the loan!
Additionally, you need to make sure YOU have adequate life insurance on yourself. If you unexpectedly die, then the loan servicing company may go after your child / borrower. You see, you as the guaranteed, back-up payer are no longer present.
5 – Get Disability Insurance On Your Child / Borrower If You’ve Cosigned A Student Loan
Your young borrower most likely won’t be able to obtain disability insurance coverage until he or she has a job. Don’t wait on this!
This insurance will pay should your borrower become disabled and can’t work. This scenario happens more than you think. Expensive, right? Wrong. If the required monthly loan payment is $500 per month, the monthly premium for a $500 monthly disability benefit is under $5 per month for a base policy.
Employer-sponsored (group) disability insurance exists, but usually is more restrictive than your own, individual policy. Additionally, group disability insurance benefits are taxable. Contrast to an individual policy, the benefit is income tax free.
And, you can then use this benefit to pay for the student loan instead of tapping into your own resources.
How does that sound?
So, for under $20 per month, you will be protected should these two events happen.
Does that sound like “selling”? No, it is responsibility.
Again, this only an example. Premiums rates depend on age, gender, health among other factors. The cost isn’t expensive, especially when balanced against the risk.
Moreover, as with the life insurance, you will want to make sure you have adequate disability insurance on yourself.
A Few More Types Worth Considering
There are other insurances to consider: critical illness and accident policies, for example. These insurances could be beneficial and provide protection, but it is best to focus on life and disability insurance first.
In conclusion, if you intend to cosign a loan:
- do your homework! Read the fine print. Is the borrower responsible and of good character to justify your guarantee? Do you understand the “fine print” in case of borrower death, disability, or inability to pay? Are you aware of the ramifications? If not, don’t sign the loan!
- ensure the borrower has the proper individual protection in case the unexpected were to happen: life insurance and disability insurance is a must.
- Make sure you have adequate protection on yourself if something were to happen. You don’t want to leave your child / borrower in a tough financial situation.
Talk to us, too. We are here to help. Feel free to contact us or use the form below. We can help you understand your situation. As we are independent, we work only for you with your interests first and foremost. Moreover, there is no risk to speaking with us. Why? Because we are beholden to you and no one else.