By Dr. James M. Dahle, WCI Founder
Plenty of doctors and other high-income professionals refinance their student loans several times between graduation and when they finally pay them off. Refinancing lowers your interest rate and allows you to put more of your discretionary income toward the principal of the loans rather than the interest on them. During the refinancing process, the question of a cosigner often comes up. There are benefits to using a cosigner, but there are a lot of risks, too. Make sure you understand both before using one.
What Is a Cosigner on a Student Loan?
A cosigner is another person who takes responsibility for your debt. That means, if for some reason you do not pay on the debt, the lender can go after the cosigner to pay it. This reduces risk for the lender and makes it more likely the company will refinance your loan and perhaps even offer you better terms. When there is a cosigner, the lender will consider the debts, income, credit history, and credit score of you AND your cosigner.
Cosigner vs. Coborrower
In addition to or in place of a cosigner, some companies may also use the terms coapplicant and coborrower. A coapplicant is simply a coborrower before the loan is approved and disbursed. A coborrower is legally equal to and, in fact, is another primary borrower. A cosigner, however, is simply guaranteeing the loan to the lender and does not benefit from the loan.
Cosigning makes sense when the cosigner wants to be released from responsibility for the loan in the event of
- Death or disability of the primary borrower (does not always occur, read the fine print).
- Refinancing of the loan.
- Release of the cosigner after a certain number of payments are made.
Coborrowing makes sense when the coborrower is benefitting from the loan and wants some control over the asset paid for with the loan, an obvious impossibility as far as student loans go. With a mortgage, a coborrower's name would be on the title but a cosigner's would not.
The main thing to be aware of is that it is harder to get out from under a student loan you coborrowed than on one you cosigned. With student loans, the usual situation is cosigning, not coborrowing.
Who Can Cosign My Student Loan? Can a Parent or Grandparent Sign?
Many student loans require a cosigner. Typically, the only people who will cosign a loan are people who care about you very much, and they're usually people who have great faith in your ability to repay the loan (despite the lender's apparent lack of faith). That usually means a friend, partner, spouse, sibling, parent, grandparent, or another family member. Seventy-three percent of the time, the cosigner is a parent, but the lenders care far more about the cosigner's financial status than their relationship to you.
Do You Need a Cosigner to Refinance Student Loans?
I don't know, do you? The only way to find out is to apply. If you need a cosigner, the lender will tell you. The stronger your credit history/score, the higher and more stable your income, and the lower your debt-to-income ratio, the less likely you'll need a cosigner. There are no absolutes and every company is different, but consider the following questions:
#1 Do You Have a Credit Score That Is 700+?
If your credit score is in the 500-600s, expect to need a cosigner.
#2 Do You Have a Good Income?
Lenders know that if push comes to shove, you're going to pay the rent and buy groceries before you pay on your student loans. They like to see you with a consistent income high enough to take care of life's necessities with plenty left over to cover your financial obligations. If you have an income under $50,000, expect to need a cosigner.
#3 Do You Have a Low Debt-to-Income Ratio?
It isn't just about your income; if you have high debt, the lender will want to see an even higher income. If the ratio of your required debt payments to your income is higher than 28%, expect to need a cosigner.
#4 Have You Consistently Made Student Loan Payments on Time?
Have you been paying on student loans for at least a year? If not, expect to need a cosigner. Have you missed any payments or made any payments late in the last couple of years? Expect to need a cosigner.
#5 Do You Have a Stable Employment History?
If you have been unemployed recently or just had a job change, lenders are more likely to want a cosigner. If you cannot show six months of paystubs in your current job or do not have two years of tax returns showing solid self-employment (1099) income, expect to need a cosigner.
What Are the Benefits of Refinancing Student Loans with a Cosigner?
The main benefit of getting a cosigner is that it actually allows you to refinance your student loans and get all of the benefits that come with refinancing such as:
- Lower interest rate
- A single monthly payment
- Cash back
- Special deals
- Better service than federal loan servicing companies like FedLoans provide
However, the presence of a good cosigner can also improve the terms of the loan. You may get a lower interest rate by using a cosigner or perhaps be offered a shorter-term loan. For example: without a cosigner, you might only qualify for a 10-year fixed loan, but with a cosigner, a five-year variable loan with a much lower interest rate might be an option.
Can I Refinance a Student Loan as a Cosigner?
As a general rule, only the primary borrower can make decisions about the student loan. The cosigner only gets involved when the primary borrower cannot make the payments. However, there is nothing to stop the primary borrower from refinancing the loan without a cosigner, with the same cosigner, or with a new cosigner at the new lender's (and cosigner's) discretion. The influence of the cosigner is not insignificant. If you have cosigned a loan and you think the primary borrower can get a lower interest rate or even get you off the loan completely, you should encourage them to do so.
When Can a Cosigner Be Removed from a Student Loan?
A cosigner is a bit like Private Mortgage Insurance (PMI); it benefits the lender, but really provides no ongoing benefit to the borrower. So whenever possible, it makes sense to remove the cosigner from the student loan. While every loan contract is different, this usually occurs in one of three ways:
- The cosigner is released after a certain number of payments are made
- The cosigner is removed when the loan is refinanced
- The cosigner is removed when the loan is paid off and ceases to exist
What Happens If a Cosigner on a Student Loan Dies?
Most of the time, upon the death of a cosigner (which is typically proven to the lender by sending them a death certificate), the cosigner (and their estate) are removed from the loan. The primary borrower, of course, is still responsible for the loan. However, in rare circumstances, the death of a cosigner can trigger an auto-default and the entire balance becomes due immediately. This could be very bad if the primary borrower is not in a position to immediately refinance the loan without a cosigner and cannot find a new cosigner. Be sure to read the fine print before signing for any loan.
What Do Lenders Look for in a Cosigner?
Lenders care about the same things in a cosigner that they care about in a primary borrower:
- Credit score
- Credit history
- Debt-to-income ratio
They certainly want to see a debt-to-income ratio of under 50% and preferably under 28%, to protect the loan in the event that your cosigner ever had to make your entire payment.
Does Cosigning for a Student Loan Affect Credit?
When you cosign on a loan, your credit score and history are now tied to that loan for as long as the loan exists. If payments are made consistently and on time, it will improve your credit. If they are not, it will decrease your credit. If the loan is defaulted on, both the primary borrower and the cosigner will be turned over to collection agencies and be hounded by phone and mail. Both borrower and cosigner could also be sued to recover the loan amount. That loan will also factor into the cosigner's debt-to-income ratio, affecting the ability to obtain new credit.
On the flip side, the primary borrower's credit will improve by virtue of them making regular payments on this new loan. Some parents take this technique to the extreme by adding their children as a coborrower to credit cards they have had for decades. The child gets an instant credit history and a high credit score, and the parent does not even have to give them a card or let them know the card number! Ethical? Perhaps not. Legal? Certainly. In fact, there may even be situations where a parent can avoid being a cosigner on a student loan simply by putting their children on their credit cards. A manual underwriter obviously won't be impressed by an 18-year-old with a 25-year credit history, but few lenders do their underwriting manually anymore.
Risks for the Cosigner
The main risk for a cosigner is that the primary borrower may not make the payments on the loan. This is even worse than the consequences for the borrower when the borrower defaults. When a borrower defaults on a student loan, they still have the education. When the borrower defaults on a car loan or a mortgage, they still have the car or house, at least for a while. But the cosigner doesn't have anything. They do not have the medical school education, the car that can be sold, or the house to be foreclosed on. They're just responsible to make the payments.
Depending on the loan, the cosigner might even be on the hook when the primary borrower dies or is permanently disabled. This is a big reason why you should avoid cosigning on a student loan if at all possible. If it is not possible, either the primary borrower or even the cosigner should purchase term life and disability insurance on the primary borrower in the amount of the loan or loan payment, just in case.
Even if the payments are made as promised, the cosigner still loses the ability to borrow as much money as they otherwise could. That might result in having to delay purchases or investments down the line.
How to Decide If You Should Add a Cosigner to Refinance Your Student Loan
You should generally avoid adding a cosigner if you can help it. While it may be beneficial to you to get a cosigner, it puts the cosigner's finances at risk and could damage the relationship. For those reading this site, the worst-case scenario is usually just having to pay a little more interest for a year or two until you qualify on your own to refinance the student loans.
If you decide to add a cosigner anyway, you should ask yourself whether you are being compensated adequately for doing so. For example, let's say you have a $200,000 student loan at 8%. Perhaps if your working spouse cosigns, you can refinance it to a five-year loan at 3%. You are now saving $10,000 per year in interest, a not-insignificant sum. Even if you purchase a little extra life and disability insurance on the primary borrower in this situation, you should still come out ahead.
Finally, consider the relationship. Most high-income professionals reading this site will eventually arrive at a point where there is little financial strain in their lives, at which point they would not sacrifice any of their important relationships just for some financial gain. Even if it costs you a little more to preserve a relationship, I would do so. Thanksgiving dinner tastes differently when you owe money to someone across the table, even if they just cosigned for your loan. If you think the turkey tastes bad just owing some money, consider how putrid it might taste if you got behind on your payments.
Where to Refinance, with or Without a Cosigner?
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What do you think? Did you use a cosigner when you refinanced? Why or why not? How did you protect them? Comment below!
The post Do You Need a Cosigner to Refinance Student Loans? appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.