What happens if I cosign a private student loan?
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UPDATED: Aug 9, 2012
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A private student loan cosigner agrees to guarantee a loan in the event a primary borrower defaults. Consequently, a cosigner will be held responsible for the remaining balance on a student loan if the primary borrower fails to make payments.
Despite this very real and very large risk, virtually all private student loans require a cosigner due to the risk involved in lending a large amount of money to young adults with little to no credit history.
Private Versus Federal
Private student loans, unlike federal student loans, are lent by private lenders such as banks. Since these loans are not as regulated by the government as federal loans are, they typically carry higher interest rates and fees which necessitate the involvement of cosigners.
Federal student loans do not typically require cosigners. However, for interested parents, there are high limit federal student loans designed specifically for parent borrowers.
Private student loans on the other hand almost always require a cosigner simply to limit the risk of the lender lending money to a student who has minimal—if any—credit history.
Despite the seemingly obvious choice between a federal or private student loan, not all borrowers qualify for federal student loans. This is one of the reasons that private loans make up a sizable portion of the student lending market. The involvement of cosigners only eases the loan-making process.
Cosigning a private student loan is a very important and generous act since financing through private organizations is often a student’s only means of funding their college education.
A Double-Edged Sword
While cosigners are usually required for private money, they aren’t always beneficial.
Cosigners can both hinder or improve the chances of a borrower qualifying for a private student loan so borrowers should take care in their selection of a cosigner.
A cosigner’s credit history will either raise or lower the interest rate on a private student loan depending on whether the cosigner’s credit history is good or bad. In spite of the good intentions of a cosigner, a bad credit score or blemished credit history could be cause for immediate denial of a loan.
This double-edged sword isn’t being dodged by just borrowers though. Cosigners have to be wary of it as well.
Interested cosigners must realize that they are just as responsible for a loan as their primary borrowers are. This can have obvious downsides since, if a borrower defaults, the cosigner will be pursued in equal measure to repay the loan. Additionally, if a default occurs the cosigner’s credit score will also be affected.
Of course, the axe swings both ways, and if the borrower repays the private student loan on time without missed payments, the cosigner could be rewarded with a raised credit score.
Since Cosigners enter into long-term borrowing commitments, speaking with their borrower before signing any papers is a necessary step. By understanding the career and education goals of the borrower, cosigners are better able to understand if they are making a wise decision by guaranteeing a private student loan. Part of the cosigner’s necessary due diligence is reviewing the amount of the private student loan, the interest level, and any fees involved.