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Co-signing a student loan carries risk for parents

Published Sep. 6, 2014

One question is bound to pop up as college students head to campus: "Hey Mom, would you cosign for a student loan?"

And too often, the knee-jerk reaction is "Sure, why not?" Parents and grandparents feel they should help out when it comes to getting a college diploma.

"There's no boxed warning label that says cosigning a student loan may be hazardous to your wealth," said Mark Kantrowitz, a college debt expert.

But maybe there should be.

"On this loan, you're giving them the keys to your car," Kantrowitz said. "You're giving them the ability to ruin your credit."

For the student, getting a co-signer increases the chance of being approved for a private student loan. The borrower typically would qualify for a lower rate. Loan rates on private student loans vary based on credit history.

But cosigning can mean the parent or grandparent is on the hook if the student defaults. Cosigning puts their credit score at risk if the student makes late payments or falls behind.

We all have great faith in our children, but it's possible they won't get a job right away or even complete college.

Financial counselor Katie Moore said sometimes students take on so much debt that they're truly unable to repay it. She met one aunt who took on a good deal of debt for a nephew and then was not in contact with the student. She had no idea that the student loans were not being repaid.

"She actually thought he was repaying them until she got the calls," Moore said.

The aunt now faces the burden of those student loans, along with her own financial hardship after a layoff. Another point: Student loan debt typically cannot be discharged in bankruptcy.

Here are some points that parents and grandparents need to consider before cosigning for a high-cost private student loan:

Did the college student first apply for federal student loans?

Federal student loans do not require a cosigner. About 90 percent of private student loans were cosigned in 2011, according to the Consumer Financial Protection Bureau. That's up from 67 percent in 2008.

Federal Stafford Loans for undergraduate students will have a fixed rate of 4.66 percent if the loan is taken out between July 1 and June 30, 2015. Federal Stafford Loans for graduate students will have a fixed rate of 6.21 percent.

Interest rates are fixed for the life of new federal student loans, but as students borrow more each year, they're facing new loans that could have a different fixed rate.

Did the parent look into the federal PLUS loan?

Federal Grad PLUS and Federal Parent PLUS Loans are at 7.21 percent for loans taken out from July 1 through June 30, 2015.

One potential drawback is that a parent with a bad credit history cannot take out a Parent PLUS Loan on his or her own. Expect a credit check.

Under the PLUS loan, the parent is obligated to repay that loan. As a result, though, the parent does not have to worry that his or her credit will go bad if the student isn't paying the loans on time. Some parents pay the PLUS loans and have the student repay them later. PLUS loans also have more flexible forbearance options than private student loans.