The risk of co-signing student loans

Parents and grandparents who signed on to their kids’ private student loans are having trouble getting out of them, even when their student is successfully paying back the debt, a report suggests.

About 90% of co-signers who applied to be released from a private loan were rejected, according to a Consumer Financial Protection Bureau review of thousands of complaints about private student loans. Often student borrowers can’t qualify for a private loan without a co-signer and even if they do, a more credit-worthy co-signer could give them access to a lower interest rate.

Credit scores are at risk

“Parents and grandparents put their financial futures on the line by co-signing private student loans to help family members achieve the dream of higher education,” said CFPB Director Richard Cordray in a statement accompanying the report. “Responsible borrowers and their co-signers should have clear information and standards for releasing the co-signer if the time is right.” These provisions affect a small slice of the student loan market – just 8% of student loan balances were held by private lenders, according to a Wall Street Journal report. Many companies tightened their standards or exited the field completely in the wake of the financial crisis, but as financial institutions search for ways to draw in young customers who may use their products in the future, they’re increasingly targeting student loan borrowers.

In fact, more than 90% of private student loans required a co-signer compared to 67% just 10 years ago, the CFPB says. Because a co-signer is equally responsible for the loan, signing on can put their ability to access other forms of credit at risk.

Read the fine print

That’s partially why most lenders advertise the ability to release co-signers from their obligation if the borrower is paying the loan back on time and has good credit. But borrowers are rarely notified when they’re eligible to apply for a co-signer release, information on these provisions is difficult to find on lenders’ websites and the bulk of co-signer applications are rejected, the CFPB indicates.

The CFPB analysis found that many lenders don’t include a specific credit score floor necessary for releasing a co-signer. The lack of these specifics “raises questions about whether lenders have set reasonable requirements for borrowers seeking to obtain this commonly-advertised benefit,” the report notes.

Many borrowers also reported to the CFPB that their co-signer release application was rejected if the loan was ever put into forbearance, a mechanism that allows borrowers to temporarily suspend or lower payments on their loans.

Another complicating factor is that many private student loan contracts have provisions that allow for the loans to automatically be placed in default if the co-signer files for bankruptcy or dies, even if the borrower is making payments on time, the CFBP finds. Without an easy way to release a co-signer from their obligations, the primary borrower is at risk of ending up in default if something happens to their co-signer. Still, several lenders told the CFPB they don’t place loans in “auto default” anymore.

Consumer advocates advise student loan borrowers to use private loans only when they’ve exhausted all of their options for federal money. Government student loans offer borrowers a fixed interest rate regardless of their credit history, as well as a variety of safety nets and repayment options if a borrower falls on hard times.