These days, it's not uncommon for college hopefuls to take out student loans to fund their education. And in this regard, federal loans are generally best, because they not only offer favorable borrowing terms, they also don't require a credit check. The problem with federal loans, however, is that they come with borrowing caps, and if you have a child or family member whose college costs exceed that limit, they may have no choice but to resort to private loans.
Private loans, however, can be tough to qualify for when your credit isn't great, and many borrowers who apply straight out of high school don't have particularly good credit, because they have yet to establish a real credit history. If your child needs to borrow privately for college, he or she may end up needing a cosigner to get approved, or to snag a reasonable interest rate on his or her loan. And that's where you come in.
Now, you may be inclined to step up and cosign that loan so that your child or loved one can finance their education. But here are a few reasons why you shouldn't.
1. You could get stuck repaying that loan
When you cosign any type of loan, what you're effectively doing is agreeing to pay off that debt in the event the original borrower defaults on it. This means that if you cosign your child's student loan, and he or she fails to repay it, you will have to make those payments instead. That, in turn, could hurt you financially, and cause you to struggle to keep up with your own bills.
Furthermore, you could find yourself in such a situation not because your child is irresponsible, but, tragically, because he or she passes away. If that happens, you may still be responsible for paying that loan's outstanding balance. Now, you can mitigate this risk by taking out a life insurance policy on the borrower (in this case, your child) with a death benefit that's large enough to cover the loan balance. But then you're stuck paying that policy's premiums, and you may not want to go to such extremes in the first place.
2. It could hurt your credit score
If you cosign a loan on a child or loved one's behalf, and that person falls behind on payments, his or her credit score will take a hit. But guess what? So will yours. And once that happens, you might struggle to borrow money the next time you need to.
To make matters worse, lenders aren’t required to keep cosigners in the loop when payment issues or delinquencies arise. As such, you could, in theory, cosign a child's loan, assume he or she is making payments, and find out after the fact that he or she has, in fact, defaulted on that debt. At that point, your credit score could be damaged, and you'll still be responsible for stepping up and covering the debt.
3. You could have a harder time borrowing money
If the person whose loan you cosign falls behind on his or her payments, your credit score could drop. But that's not the only way cosigning a loan might make it difficult for you to borrow money. By attaching your name to that loan, you increase your own debt-to-income ratio, which measures the amount of debt you're carrying relative to the amount of money you earn. The higher that ratio, the less ideal a borrower you'll be in the eyes of lenders, which could hurt you when you apply for a mortgage, or another type of loan you need for yourself.
By agreeing to cosign a student loan, you could end up helping someone you care about fund his or her college education, thereby opening the door to different career opportunities. You might also help that person secure a much lower interest rate on that debt than he or she would qualify for individually.
That said, think long and hard before you agree to cosign a student loan, and only do so for someone you trust to be responsible with money. The last thing you want is to have your act of generosity backfire and upend your finances in the process.