Every parent wants the best for their child and a college education usually leads to better jobs and a brighter future. In the United States, college tuition for 4 year state colleges and universities is thousands of dollars a year and rising. Private institutions may charge over $50,000 a year for a 4 year program and the average student is graduating with more than $25,000 in student loan debt.
Most families are unable to meet these costs without financial aid and parents want to do everything they can to provide their children the opportunity of a better future, but you should first consider a few important factors before cosigning a student loan.
If you cosign a student loan, you assume joint responsibility for the debt. If your child does not or cannot repay the loan, you will be held 100% responsible for the total amount. Student loans can be thousands of dollars and repayment schedules can last for 10 to 30 years. There are important differences between student loans and other types of debt that cosigners should be aware of before making this serious financial commitment.
Legal Protections For Student Loan Institutions
While most debts can be discharged through bankruptcy, student loans cannot. The only way to remove student loans from your credit is to pay them in full. If the loan is in default, the lender can seize your tax refund for payment. If the loan has not been paid off before you retire, lenders can garnish social security checks. Like diamonds, federal student loans are forever – they never become void, lenders can pursue responsible parties for decades, and there is no statute of limitations.
My Child Is Responsible, I Don’t Have to Worry
As the MetLife commercial says, life is full of “What Ifs?” Accidents and illnesses happen and if your child becomes disabled or dies before the loan is discharged, you will still have to pay the debt. In today’s economy, many new college grads are unable to find a job immediately. If your son or daughter is unemployed, there may be a grace period of 6 to 9 months, but the debt will still have to be paid afterwards and you will have to begin making payments.
Although student loans usually have a lower rate of interest than most other types of debt, it still can cost you thousands of dollars in retirement funds before your child is financially-secure enough to start making payments.
If your child is unemployed for a prolonged period of time and the student loans become due, urge them to check out easy jobs that pay well in the interim time period to help them make payments and cover their daily expenses while their “dream job” or career of choice becomes available.
Even while in college, if study schedule permits students can look for side gigs. here’s one list of job options for college students that I made.
If you cosign a student loan, the amount of the loan appears on your credit record and can have a significant impact on your debt to income ratio. Even if you have a great credit score, your debt to income ratio is an important consideration for lenders, especially when considering a mortgage loan for a new home. Cosigning a large student loan could mean that you would be unable to get a car loan or buy a house even though your child is the primary debtor and is making regular payments on the loan. If regular payments are not made, it will negatively affect your credit score as well.
What About Other Children?
When cosigning a student loan for one child, parents should consider the possible effects this financial burden could have on other family members. Parents with 2 or 3 children may not be able to cosign loans for any of their other kids, and it would be unfair to help one and not the others. If cosigning for one child means denying another the opportunity for higher education, parents should think long and hard before making a decision that could create family conflict for the future.
Money is one of the most contentious issues in any relationship and can have ramifications parents do not even consider. If your child does not pay the loan and you have to make sacrifices to cover the repayments, how will it affect your relationship? If your child does pay the loan, will you use the fact that you cosigned to “guilt” him or her into providing financial or emotional support as you get older? If helping your child now will cause problems down the road, it may be better to let your child handle their own financial issues by applying for grants and academic/athletic scholarships.
Types of Student Loans
There are two types of student loans, federal loans and private loans. Most students do not need cosigners to qualify for federal student loans because they are designed for young people with little or no credit history. The interest rates are low and federal loans have deferments, forbearances and graduated payments for flexibility. Federal loans also offer forgiveness of part or all of a loan for students who enter the public service sector or armed forces after graduation.
The best federal loan is the subsidized Stafford loan because the government makes interest payments while the student is still in school, which does not allow interest to capitalize and increase the principle. The benefit of this is that subsidized loans are effectively interest-free loans from the government, so you can invest your cash, grow your money, and pay the government back later with inflation-adjusted dollars. Just be sure to focus on safe investments to avoid losing the principle and incurring unnecessary financial strain when paying the loan later.
Unfortunately, subsidized Stafford loans are limited to $3,500 for first-year undergraduates, $4,500 for second-years, $5,500 for third-years and beyond, and a dependent student may not borrow more than a total of $23,000 in subsidized Stafford loans. The interest rate for dependent, undergraduate students seeking direct subsidized Stafford loans is 3.4% for funds disbursed between July 1st, 2012 and June 30th, 2013. Rates are expected to stay this low for the foreseeable future.
Private loans from commercial lending institutions generally have much higher interest rates than federal loans and often require a cosigner. Repayment options can be limited and these loans may not defer repayment until the student has completed school, meaning interest accrues immediately and is added onto the principle. Unlike federal loans which base loan payments on income, private loans usually have set payments.
Parents and students should research all other financial aid options before considering a private student loan, and if you have membership to a credit union, consider a credit union vs. bank student loan since CUs often charge lower interest rates and fees.
Before applying for any student loans, parents and students should research scholarships and grants. This is free money that usually requires no repayment. Public funds are available through state sponsored Hope scholarships and federal Pell grants, if students qualify. There are also thousands of private scholarship funds, though it may take some research to find all the programs for which a student is eligible. If a child can pay for school with scholarships and federal loans, they may not need a cosigner.
How Can I Say No?
Every parent has to say “no” to their child sometimes. If you decide you are unable to take on the financial responsibility for cosigning a student loan, explain your reasons to the child and try to answer any questions they may have. Discuss alternatives like less expensive state colleges, federal and state grants and loans, scholarships and aid directly from your university. College students are nearly adults and dealing with their own money problems can make them stronger, more responsible people.
While helping your child is commendable, cosigning a student loan can have long term financial consequences for your family and can change your relationship with your child. Endangering your own financial future is irresponsible and could create serious problems as you age. If you are confident that you will be able to repay your child’s loans if necessary, then go ahead and cosign. If cosigning will mean that you and the rest of your family are put in financial jeopardy, then exhaust all other financing options first.
This was a guest Post by Gary Dek, who is a personal finance blogger who focuses on investing, saving, credit/debt, career and education advice, real estate, frugality, insurance and how to make money online at Gajizmo.com. Gary has worked at an internet company on their M&A team, as well as two private equity firms.