Is your college-bound child a good credit risk?
Consider this very carefully before co-signing a private student loan.
Some 49% of private student-loan co-signers over age 50 end up paying some of that debt, according to data released in May by the AARP Public Policy Institute.
Half of them, mainly parents and grandparents of the borrowers, voluntarily do so to help out. But the rest pay only when the student defaults.
"Some people co-sign and don't realize that they will be responsible ultimately if student borrower does not pay," said Lori Trawinski, director of banking and finance at the AARP Public Policy Institute.
The risks go beyond just having to pay bills. One missed payment will tank credit scores of both the borrower and cosigners. Miss more and you go into collections, which will damage all of your finances for years to come.
It is very easy for months to pass in default if the student is trying to hide what is going on, said Ken Ruggiero, president and chief executive of Ascent Funding, a private student lender based in San Diego.
"There is confusion about who owes the bill. Meanwhile, the calendar is ticking by," Ruggiero said.
Private student loans make up about $120 billion of the $1.5 trillion in U.S. student-loan debt, according to the AARP study. Almost all are co-signed loans, because students rarely have the credit history or income to qualify on their own.
At College Ave Student Loans, for instance, 96% of its $2 billion in loans are co-signed.
Families typically turn to private loans to cover shortfalls after they exhaust the limits of federal loans for students as well as their savings.
Parents can also get federal Parent PLUS loans, which come with low interest rates, very few restrictions, and some income-based repayment options. But, according to AARP's data, more families turn to co-signing private loans in students' names.
"Both are pretty poor products in terms of protections and options," said Adam Minsky, an attorney who focuses on helping student loan borrowers in both Massachusetts and New York. That said, he recommends a Parent PLUS loan over cosigning a child's student loan.
Interest rates are a key factor. The 2018 rate for PLUS loans was 7.6%, while private loans vary. At Ascent, which has about $50 million in loans to date, variable rates range from 4.23% to 13.23% and fixed options range from 4.98% to 14.16%, depending on your credit history and other factors.
Even Ruggiero said of Parent PLUS loans: "If you have bad credit, it's a screaming deal."
Another point to consider before you sign a loan is consumer protection. Borrowers can discharge a federal loan in case of a disability or death, Minsky said. Private loans do not offer that option, and parents could be on the hook, even if their child passes away.
Co-signers can ask to be taken off a private loan if repayment is going well. But the process is not transparent or simple.
"Lenders have total discretion. Even if you meet requirements, they don't have to go through with it," said Minsky, who has rarely seen it happen.
The easiest way to avoid bad loan choices is to pick a school the family can afford.
"We need people to not have to rely on debt to finance education, and we need more options that are cheaper," Minsky said.
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