Cosigning student loans: When to do it — and how to plan your exit strategy
Many parents are faced with the prospect of having to cosign a student loan to help their child pay for college. It’s rarely the ideal situation, but given the costs of higher education now, and the often nonexistent credit history of the average 18-year-old, it’s unavoidable for many families.
Of course, you want to do the right thing and help your kids establish their own financial futures. But it is critical that you strike the right balance between helping your child pay for college and making sure that you’re planning appropriately for your own retirement. Afterall, straining your finances to help your child only for them to have to step in and support you later isn’t a great tradeoff for anyone.
So, whether you’re considering cosigning a loan or did so some years back, you need a plan to ensure those loans end up squarely on your child’s plate — and that your child knows about, and is prepared for, that outcome.
Considerations for cosigning a student loan
Deciding when/if to cosign a loan requires weighing many factors. First off, you need to assess your current financial situation and account for any expected upcoming changes or big expenses.
In practice, that means being realistic about how close you are to retirement, financial needs related to any other kids headed off to college, or other looming expenses you anticipate such as a home renovation or purchase, medical care, a new car, etc.
The hope when cosigning a loan is that you’ll never have to make a payment because the primary borrower, your child, will handle it. But the fact is, if they run into any financial issues you’ll be on the hook for those payments. And let’s be honest, financial strain is pretty common for people who are newly out of school and just starting to build their careers. You need to be sure you’ll have the flexibility to pay those loans if needed — whether that’s a one-off payment during a cashflow crunch or covering them for a few years due to a serious setback.
There are other financial implications to cosigning a loan, even if the costs fit easily within your budget. Cosigning a loan can impact your ability to take out other loans since it shows up on your credit report even if you never have to make a payment. (Your credit score will also take a temporary dip after you apply and the lender does a “hard pull” of your credit history.) if your child misses any payments, that will also bring down your credit score. Finally, only the primary borrower can deduct the interest for a cosigned loan, so don’t count on that tax benefit offsetting the risk you’re taking on by cosigning.
If cosigning a loan isn’t the best fit for your circumstances, that doesn’t mean you can’t still help. Through the FAFSA application, you can apply for a Parent PLUS loan.
Parent PLUS loans are federal student loans designed specifically for parents (hence the name) who are helping their children pay for college. To qualify, you need a “non-adverse” credit history. (If you have less-than-perfect credit there are still options to help you qualify.) You also must be the biological or adoptive parent of the student. While grandparents, legal guardians or even a close family friend can cosign a loan, Parent PLUS loans are only for parents. Parents can borrow up to the cost of their child’s attendance at school each year, minus any other aid the student receives.
Parent PLUS loans have a fixed interest rate which is a little higher than the rates for student loans. More importantly, they are solely in the parent(s) name — your child has no legal responsibility to pay it back and it can’t be transferred to them.
If you decide you’re willing to cosign a student loan you need to have an open and honest conversation with your child about your expectations for what you can pay, a strategy for ensuring what and how much they’ll pay after they graduate, and a plan for when and how you can be removed from the loan. (We’ve got more on that in the next section.)
Everyone involved should have the same expectations for who is handling what. You’re doing this to help your child; the last thing you want is for an issue to crop up years later and cause an unpleasant surprise or even damage your relationship. (Even if you cosigned that loan years ago, it’s worth revisiting the conversation periodically to ensure it still works for everyone.)
That strategy should also include dealing with less likely, but very possible scenarios such as what happens if the loan cosigner dies or goes bankrupt. (In those cases, the lender may have the right to demand the loan be paid off immediately.)
How to remove a cosigner from a loan
The good news is you can eventually be removed from any loans you’ve cosigned. But as the primary borrower, your child is the one who actually has to do it. You can’t remove yourself. (That’s another reason you want to have the conversation with them about repayment expectations early and often.)
When it’s time for your child to take over the loan, the two options for removing a cosigner are to transfer the loan to the primary borrower or refinance it.
Transferring/Removing yourself from the loan
Transferring the loan essentially means that your child, aka the primary borrower, has to show the current lender that they’re more creditworthy now and able to handle the loan payments on their own. After all, the lender wouldn’t have required a cosigner if they didn’t have concerns about the student’s ability to make the loan payments.
Be aware that you’ll most likely have to wait until at least a year after your child starts repaying the loan (typically a few months after they leave school) until they can even begin this process.
Every lender has their own criteria for deciding when the primary borrower can take on the full burden of the loan, but in general, to get approved your child will need to show that they have:
- a longer credit history and/or a higher credit score than they did when the loan was originated
- an on-time payment history (this can be anywhere from 12 to 48 months of principal-and-interest payments)
- a solid work history and/or income
- minimal other debt
It may take a few weeks for the lender to finish its review, but once it’s satisfied, it’s just a matter of signing a few forms (and maybe a sigh of relief on your part) to have that cosigned loan transferred solely into the primary borrower’s name.
Refinancing the loan
Another option is for the primary borrower to refinance the loan with either the same lender or a new one. The process and the needed information are very similar to transferring the loan. Your child will have to show that they have the means and credit to take on the loan by themselves.
However, refinancing has another possible benefit: Your child may be able to refinance into a loan that has better terms (a lower interest rate, a more appropriate time frame, etc.) than the original loan.
What if they can’t get the cosigner removed?
The fact is, not all cosigners can be removed from the loans they took on. Even if your child does eventually get approved to transfer or refinance their loan, it may not happen for a few years or the first time they apply.
That doesn’t mean you’re entirely out of options.
If your child can’t refinance on their own, you can refinance with them to get better loan terms. While you’ll still be a cosigner on the loan, this provides two benefits for you and your child. First, more favorable terms can help your child improve their credit profile and hopefully get to a place where they can take on the loan solo a little faster. Second, if they do need you to step in and make a payment, it should be more affordable for you as well.
Cosigning a student loan for your child may not have been in your original financial plans, but it may be the best way to give them a leg up as they invest time, energy, and yes money, in their future. But helping your kid doesn’t have to hamper your own financial health. Having a strategy for how and when your child can take over the loan — and helping them achieve that — benefits you both.