90% of All Private Student Loans Require a Co-Signer – And 90% of All Co-Signer Releases Are Rejected By Lenders. What Does That Mean For You?
Posted By Donna Fuscaldo on October 7, 2015 at 2:12 pm
For some people, private student loans are the only way to get a college degree. And most people need someone to co-sign that loan.
Consider this: in 2012, 90 percent of all private student loans required a co-signer, according to the Consumer Financial Protection Bureau and the Department of Education. What’s more, the CFPB found that 90 percent of co-signer releases are rejected by lenders.
Co-signers play an important role in the private student loan market – even more so since the financial crisis ushered in stricter underwriting standards. But being a co-signer is fraught with risk. After all, most borrowers that turn to private student loans have already maxed out federal loans, creating a pile of debt they will owe upon graduation.
“Whether it’s a college loan, car loan or business loan, there’s a chance they are never going to pay it back,” says Patrick Simasko, elder law attorney and principal of Simasko Law. “If the child doesn’t pay, it will affect the co-signer.”
Private loans make up a small portion of the overall student loan market, accounting for 7.2 percent in the first quarter, according to MeasureOne, the student loan data provider. The default rate is around 3 percent, with delinquencies and charge-offs at the lowest levels since the first quarter of 2009.
Co-signing comes with risks
Even though defaults aren’t as high as they are in the federal student loan market, the decision to co-sign someone else’s loan has to be considered carefully. Co-signing a student’s loan is a long term commitment, and one that can impact your financial stability. Private student loans can have terms as long as twenty five years, and if the borrower can’t pay it back and defaults, it becomes the co-signer’s problem. If the loan goes into default and the co-signer isn’t aware of it, the outcome can be particularly devastating.
“If the kid doesn’t pay, there goes the FICO score and the debt to income ratio,” says Ron Them, co-founder of the National Institute of Certified College Planners. “Usually there are long commitments on these loans. It can create some real family strife.” If a borrower defaults, it adds to the co-signer’s debt load, which could get in the way of the purchase of a new car or home. There’s even cases where co-signers were put in collections and sued over unpaid loans, says Them.
Getting off the hook is easier said than done
Co-signing may not seem like a big deal, since many lenders will promise to release the loan anywhere from 12 months to three years after making regular monthly payments. However, it turns out it’s not always that straightforward.
The CFPB studied 3,100 private student loan complaints and around 1,100 debt collection complaints related to student loan debt received from October 1, 2014 to March 31, 2015. They found that many lenders advertised options to release a co-signer from the loan, but very few actually released them. The CFPB notes that co-signers get very little information on the criteria necessary to get released.
“Parents and grandparents put their financial futures on the line by co-signing private student loans to help family members achieve the dream of higher education,” CFPB Director Richard Cordray said in a recent press release. “Responsible borrowers and their co-signers should have clear information and standards for releasing the co-signer if the time is right.”
Auto-default clauses are still part of many contracts
Another risk co-signers have to be aware of is the auto-default clause. Last year, the CFPB found that some private student loan servicers would place borrowers in default if a co-signer died or filed for bankruptcy, even if the loans were being paid on time. Some financial institutions said they would give up the practice, but the CFPB says most private student loan contracts still have auto-default clauses. If the auto-default kicks in, the borrower has to pay back the loan in full immediately.
For co-signers with good credit, a private student loan may seem like the cheapest way to borrow money toward their child’s education. But saving a couple of percentage points on interest may not be worth it if your child defaults and you are on the hook for it. If you are going to co-sign, make sure you’ll be able to handle the payments if your child can’t. “You have to have a plan for when it goes bad,” says Simasko. “Because you don’t want to figure it out when they can’t make the payment.”