It seems like such a harmless endorsement: Co-signing a student loan for dear, sweet Madison, the apple of your grandmotherly eye. Of course, you want her to go to college; of course, you're willing to vouch for her! Too bad you won't have much spare cash to help her out, now that you're close to retiring. But it doesn't take any money out of your pocket to co-sign a loan, so why not give this lovely child the benefit of your excellent credit rating?
Here's Why: You Could Get Stuck Repaying That Loan.
And you wouldn't be alone: The Federal Reserve Bank of New York (FRBNY) says there are 2.2 million people 60 and older who owe a total $43 billion in student loan debt – an average of nearly $20,000 apiece.That's a surprisingly large non-mortgage debt for people about to retire, especially since in 2001, barely more than a dozen years ago, households headed by this 60+ age group owed so little on student loans that their share rounded down to 0%.
Yes, some few retirees may have borrowed to go back to school themselves — to satisfy a life-long desire for a PhD in art history, perhaps. But mostly they have borrowed or co-signed to send laid-off members of their families back to grad school during the Great Recession or co-signed for the undergraduate generation.
Sometimes these good deeds came back to bite them. And bite them hard: In 2013, 12.5% of student loans held by seniors were more than 90 days behind. By year-end 2012, there were already 115,000 retirees whose Social Security benefits were being garnished to pay back student loans. Since only the federal government can garnish Social Security benefits for this purpose, this figure does not include all of those who’re behind on private student loan payments.
Losing 15% of your Social Security check – the most the feds can seize – is no fun. The collection process on private loans could be even less pleasant.
Learn the Legalities of Co-signing
First, consider the fact that if someone needs a co-signer, it’s because they do not qualify for credit on their own. You are taking a risk that the professional lender is not willing to.
– By co-signing, you accept the legal obligation to repay the loan on the terms outlined i n the credit agreement. If the primary borrower doesn’t pay for whatever reason, you will have to.
– The amount may snowball. You may have to pay late fees or collection costs. A loan that has been deferred may have accumulated additional interest on the principal.
– A loan made to a student is based on future earning power – intellectual assets, if you will, rather than real property like a house. But when you co-sign, you are putting your real assets on the line.
Face Up to the Risks of Student Borrowing
Young people today are graduating into a very tough job market. In 2013, monthly unemployment rates for Americans aged 20-24 ranged between 11 and 13%, not a pretty picture. Many who are working have minimum-wage jobs with fewer than fulltime hours. They may not be able to keep up with loan payments. One study of the Class of 2005 found that five years later, only 40% of borrowers had made payments as outlined in their credit agreements.
– Even if your beloved Madison is able to repay on schedule, her debt is added to your total financial exposure on credit reports. On a reduced retirement income, that may give you an unfavorable debt-to-income ratio – a problem if you need to buy a car or major appliances, refinance an existing loan or mortgage, or raise cash for some other need.
– The margin for error is slim-to-none. “Missing just one student loan payment puts a borrower in delinquent status,” the National Association of Consumer Bankruptcy Attorneys (NACBA) reports. “After nine months of delinquency, a borrower is in default.” Goodbye to that excellent credit rating.
Michigan’s Attorney General Bill Schuette points out, “The creditor can collect this debt from you without first trying to collect from the borrower. The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc.”
Student loans are virtually inescapable; not even bankruptcy wipes them out. The NACBA warns: “While any default hurts a borrower’s credit, the consequence of a default on a student loan is particularly onerous. Once a default occurs, the full amount of the loan is due immediately. The government also cuts off any future federal financial aid and strips the borrower’s eligibility for loan forgiveness.”
How You Can Try To Protect Yourself
There are a few safeguards you may be able to build in if you feel you must sign for someone very near and very dear. One is a written guarantee that the lender will make every effort to get repayment first from the primary borrower before coming after you.
Another safeguard is to establish your right to withdraw after the loan has been properly paid by the primary borrower for the period specified in the loan agreement. A common term is 36 up-to-date payments; Sallie Mae’s Smart Option Plan requires only 12, which is unusually short.
Don’t count on being able to get a release, though, since one of the top complaints of borrowers is the difficulty of fighting through multiple barriers raised by lenders.
As the credit reporting bureau Equifax’s Chief Economist Amy Crew Cutts points out, “Student loans is one area of lending not affected by the tighter underwriting standards since the start of the recession.”
Also, be aware that state laws that govern credit agreements may not support your efforts to get these provisions written into private loans. (In the state where the contract is executed, check the attorney general’s website for information.)
– Monitor the loan constantly so you know if it's close to default and you can step in to take over payments to stay current. Arrange your direct access to account information with the lender at the time of co-signing so that it’s built into the contract.
– Keep track of the primary borrower's whereabouts. Good communication between you is the best early warning of problems. Do this for the life of the loan.
– Private lenders and the federal government use third-party debt collection services. These may become very aggressive. Early in May 2014, the Justice Department reached a $96 million settlement with Navient, part of the large lender Sallie Mae, over its charging illegally high interest rates and late fees on student loans to military service members. (Navient admitted no wrongdoing.) The following week, the National Consumer Law Center filed suit against the U.S. Department of Education for allegedly violating the Freedom of Information Act by withholding records of its bonus plans to contractors that in effect, incentivized overly hard-nosed – and often outright illegal – debt-collection practices.
If you already have inked the line for someone, brace yourself: The situation on loan repayments is actually worse than it looks. Because students can stop the clock on repaying many loans by re-enrolling in school or by using deferral plans, some experts say there is a even higher, so-called “hidden delinquency rate” whose reckoning day is still to come. It’s a good idea to find out what consumer protections may be available to you now, just in case.
The Bottom Line
By far the safest path is not to co-sign anyone’s student loan, but if you feel you must, or if you already have, stay on top of it. And take care of yourself – if you should die suddenly, the balance of the loan may come due all at once and swamp the finances of the very person you've been trying to help.