Private student loans: A cautionary guide to your options

Spring is in the air! The tulips are blooming, college acceptance letters are zooming into email inboxes, and the majority of parents with college-bound students are panicking about paying for their kid’s schooling.

Ain’t this time of year grand?

There’s a lot that families can do to tame the cost of higher education, starting with filing the Free Application for Federal Student Aid (FAFSA) which determines a student’s eligibility for federal aid, applying for scholarships and grants which don’t need to be repaid, and considering the cost of attendance when comparing college acceptance offers.

But for some college students, there is a funding gap between their federal student aid–which includes federal student loans–and their total cost of attendance. If students or their parents can’t afford to pay the difference out of pocket, just over 9% turn to private student loans. And among undergraduate students, 92.45% of those private student loans are cosigned–often by Mom or Dad.

Unfortunately, cosigning your kid’s private student loan can put your credit score, your retirement, and even your relationship with your child at risk.

Here’s what you need to know about the unexamined dangers of cosigning your child’s private student loan.

Student loan debt by the numbers

There are 42.8 million federal student loan borrowers who owe a total loan balance of $1.693 trillion, which represents 90.9% of all student loan debt. Private student loans make up only 9.13% of all student loan debt, for a total loan balance of $133.4 billion.

There’s an excellent reason why most student loan debt is federal: borrowers do not need to meet credit or income requirements to qualify for federal student loans. Additionally, interest rates on federal loans are set by Congress and are the same for every cohort of borrowers. The government also offers guaranteed benefits, such as income-driven repayment plans, potential loan forgiveness, and forbearance options.

Unfortunately, 10.3% of student borrowers default on their loans within the first three years of repayment, and an average of 6.24% of student loan debt is in default at any given time.

While the professional number crunchers haven’t teased out precisely how many of these defaulted loans are federal and how many are private, it’s safe to assume that there are a non-zero number of private, cosigned student loans going into default every year.

Parent PLUS vs private student loan

If you and your student have exhausted your federal student aid options, including scholarships, grants, federal student loans, and work-study programs, and you still have a funding gap, there are generally two loan options left.

Parent PLUS loan

A federal Parent PLUS loan allows the parent of a dependent undergraduate student to borrow up to the cost of attendance, minus any other federal student aid your student has received, on the student’s behalf.

Like your student’s federal loans, PLUS loans offer multiple repayment options and allow for deferment and forbearance, although there is no path to loan forgiveness. You also cannot transfer your PLUS loan to the student you took it out for.

You must not have an adverse credit history to qualify for a PLUS loan, even though this loan doesn’t require the same kind of credit check a traditional private loan uses to determine your interest rate. So it’s possible to be denied a PLUS loan, although there are workarounds–you may be able to explain the extenuating circumstances or get an “endorser,” i.e., a cosigner.

Like your student’s federal loans, PLUS loans have interest rates and fees set by the federal government, and they aren’t cheap. Currently, PLUS loans have a fixed interest rate of 8.94% and an origination fee of 4.228% which is deducted from the amount disbursed.

Additionally, while you can choose to defer PLUS loan payments until six months after your student leaves school, interest will accrue while they are in school, unless you make payments.

Private student loans

There are myriad private lenders with student loan products that can help dependent undergraduates bridge the funding gap. The problem is that the vast majority of undergraduate students don’t have the minimum credit score or income requirements to qualify for a private student loan on their own. Typically, private lenders require an established credit history, a credit score in the mid 600s, and a minimum income of $24,000–which is a tall order for an 18-year-old.

But these requirements aren’t such difficult hurdles for the average parent of a college student. In fact, if you have a decent credit score and a good income, you may help your student qualify for a favorable interest rate.

But private loans are more likely to require immediate repayment, rather than allowing for a deferment until your student is done with school. In addition, private loans have no path to forgiveness, few repayment plan options, and zero federal protections.

What it means to cosign

A recent survey of parents who cosigned private student loans for their students found that one-third of respondents did not fully understand the risks of cosigning. Specifically, if you cosign a loan with your kid, this is what you’re signing up for:

• You are legally responsible for the loan. If your child doesn’t make payments, creditors will come knocking on your door.
• If your child makes a late payment, it will affect your credit score. It doesn’t require a missed payment or a default for the cosigned loan to hurt your credit. According to the survey, 56.80% of cosigners believe that their credit scores were negatively impacted by cosigning the loan.
• The loan may affect your ability to get credit. If you want to apply for a mortgage or car loan, having the cosigned student loan on your credit report may make it difficult to qualify. That’s because the total amount owed will be included in your outstanding debt and the monthly payment is calculated as part of your debt-to-income ratio (how much of your income is earmarked for debt obligations), even if your child is entirely handling the payment on their own.
• You may be on the hook for up to 10 years. Depending on the loan, you may be stuck as a cosigner for the entire life of the loan–although some private lenders offer cosigner release after a set number of on-time payments.
• The loan may hurt your retirement. According to the survey, over half of cosigners feel that their child’s student debt is putting their retirement at risk. This may be related to the fact that nearly two-thirds of respondents have helped their kids with monthly payments.
• The loan may sour family relationships. Money has a way of magnifying old hurts and resentments. Cosigning a loan not only leaves you vulnerable to financial and psychological disappointment if your child falls behind on payments, but it can also open up the whole family to emotional distress if the student has siblings who you help in different ways.

Cosigning can be a risky business

The pressure you’re feeling to bridge the funding gap at Big Bucks University is real, especially if your kid has dreamed of attending BBU for years. But there’s a real cost to cosigning a private student loan to help your child pay for their education, and it’s important to slow down and consider the risks before you sign.

To start, remember the massive size of the national student loan debt. Your child is about to become one of the 42.8 million federal student loan borrowers who owe a total loan balance of $1.693 trillion.

Unfortunately, more than one out of every 10 borrowers defaults on their student loans within the first three years of repayment. Minimizing the amount your student borrows can help protect them from becoming part of this statistic.

If you are facing a funding gap, you generally have two options: a federal Parent PLUS loan that you take out, or a private student loan you cosign with your student. The Parent PLUS loan has an 8.94% fixed interest rate and an origination fee of 4.228%, and borrowers must not have adverse credit history. The PLUS loan offers some federal protections, but fewer than the loans your student is taking out on their own behalf.

Cosigning a student loan with your child may offer a lower rate, depending on your qualifications, but it puts you at risk of taking over the loan if your child defaults, hurting your credit if your child makes a late payment, affecting your credit, hurting your retirement, and potentially souring family relationships.

If you and your kid go into cosigning a loan with your eyes wide open, your expectations explicitly spelled out, and an iron-clad agreement about how many times you’re each allowed to roll your eyes, it can be a viable method of filling a funding gap.

But without clear expectations in place, a cosigned loan can become the beginning of the kind of tragic family story Aunt Gertrude tells when she’s feeling maudlin.