Student Loan Collateral Damage

When we think about the $1.45 trillion student loan crisis, we normally imagine struggling, young, recent college graduates. We often don’t think about the collateral damage among families that overwhelming school debt can inflict, but that’s a fast-growing problem. Almost all private student loans require a co-signer, and increasingly, the parents and grandparents tied to these debts are running into trouble — lower credit scores, higher borrowing costs, and threatened retirement are just a few of the consequences.

Co-signing a loan is, legally, just about the same thing as taking out a loan. If a former student misses a payment, the co-signers credit score can suffer. If there is a default, parents will get a call and a bill from the bank — even a decade or more after graduation. That can leave parents deep into their 60s and 70s burdened by a risky financial booby trap that might be only a surprise job loss away from springing. That’s why it’s common financial advice to avoid co-signing on loans at all costs.

Still, it’s hard to say no when your child has been accepted into the school of their dreams, and there’s not enough federal student loans for students to cover costs. Some parents can make up the gap with cheaper Parent PLUS loan, but only about one-quarter of older borrowers surveyed by the Consumer Financial Protection Bureau trace their debt to PLUS loans.

That sends students and their families toward private lenders, who since the great recession and basically insisted on co-signers for students who don’t have established credit. (That’s most of them). About 90 percent of private student loans are co-signed by a parent, according to a 2012 report by the CFPB and the Department of Education. And about 7.5 percent of student loans are private loans, according to MeasureOne. That means millions of parents and other family members and guardians are ignoring accepted financial wisdom and taking the co-signing plunge anyway.

The risks are real, and getting worse, according to a recent survey by LendEDU. Here the bleak findings:

06% of parent cosigners stated their credit scores have been negatively impacted by cosigning on private student loans (compared to 56.80% last year)
31% of parent cosigners said cosigning has hurt their ability to qualify for a mortgage, auto loan, or other type of financing (compared to 34.40% last year)
93% of parent cosigners felt as if their children’s student debt is jeopardizing their retirement (actually down slightly from last year, probably because of recent stock market gains).

There’s more to worry about from that LendUDU study:

45% of co-signers said their child had made a late payment
47% say the loan puts their retirement in jeopardy
66% said the borrowers have asked parents to make a payment
75% have helped borrowers make payments
43% of co-signers said there had been a late payment that hurt their score

The problem is showing up in government data, too. The number of consumers age 60 and older with outstanding student loan debt quadrupled from 2005 to 2015, increasing from about 700,000 to 2.8 million, according to the Consumer Financial Protection Bureau. The average amount of student loan debt owed by borrowers age 60 and older roughly doubled from 2005 to 2015, increasing from $12,100 to $23,500. As of 2015, borrowers age 60 and older owed a total $66.7 billion in outstanding student loan debt, and 73 percent of student loan borrowers age 60 and older report that their student debt is owed for a child’s and/or grandchild’s debt.

There are other risks from co-signing which might not be as obvious. For example, many parents might not realize that the lender is under no obligation to alert the co-signer if the primary borrower falls behind. The first indication will probably be a drop in their credit score, followed by an uncomfortable conversation with their adult child.

Meanwhile, there are some risks in the reverse direction, too. Former students can get in hot water based on something that happens to their co-signer. Another CFPB report found that private student lenders and servicers placed borrowers in default when a co-signer died or filed for bankruptcy, even if the loan was in good standing.

Keep in mind that student loans can be a very long-term problem. A recent study by the Brookings Institution concluded that loan default rates continue to steadily increase as borrowers enter their 30s and even their 40s. The report claims that nearly 40% of students who first borrowed for school in 2003-2004 may default by 2024.

So what are co-signers to do?

There was a bit of good news in the LendEDU survey. Banks require co-signers because few 18-year-olds have established credit, so it stands to reason that when a former student is now a gainfully employed adult with good credit that there would be a reasonable way to let parents off the hook. There is: It’s called a co-signer release. The survey found an increase of 5.50 percentage points in cosigners who asked their private student loan lenders for cosigner release.

It should come as little surprise that banks aren’t anxious to hand these out, however. When there’s a debt, the more potential for recovery, the better. Rules can vary, but generally banks can require up to 36 consecutive on-time payments and other forms or proof that the borrower is a good credit risk, before granting a release. Even so, the CFPB found in 2015 that 90% of private student loan borrowers who applied for a co-signer release were rejected by lenders. Some bank policies can ban co-signers from ever obtaining a release – if the primary borrower utilizes a forbearance, for example.

So if you are considering co-signing a loan, what should you do now? There are hints in the LendEDU study. For starters, here’s the very bad news: 31% of co-signers surveyed said they did not fully understood the risks of cosigning. So, start there; know the (very real) risks. And given the high rate of credit score impacts and other issues, 38% said they regret co-signing.

On the other hands, parents want to do everything they can to help their kids, and most – fully 66% — said they’d clench their teeth and do it all over again, despite all the drawbacks. If that’s you, make sure you do everything you can to insulate yourself from risk. That means an ongoing clear conversation with the borrower about the state of the loan, even long into adulthood. It means checking in on the status of loan payments.

It also means being realistic about the odds that the loan will run into trouble at some point. Here’s a few further sobering LendEDU findings about how unprepared current college students are to successfully repay their loans:

94% of Gen Z borrowers believe they will be helped by federal student loan forgiveness programs after college. In reality, less than 10% of borrowers will be aided by forgiveness
12% of Gen Z borrowers thought it was possible to refinance student loan debt with the federal government, but no program exists
77% of Gen Z borrowers either answered “no” or “unsure” to a question asking if unsubsidized student loans accrue interest during deferment
A combined 39.18% of Gen Z borrowers either answered “no” or “unsure” when asked if they would be able to fully repay their student loan debt
24% of Gen Z borrowers have never looked at their student loan account and 19.76% of them were unsure if they had private student loans

That means, more than ever, parents who co-sign need to spend a lot of time talking to the beneficies about their responsibilities during school, and after graduation.

If you’re concerned about your credit, you can check your three credit reports for free once a year. To track your credit more regularly, Credit.com’s free Credit Report Card is an easy-to-understand breakdown of your credit report information that uses letter grades—plus you get two free credit scores updated every 14 days.

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Image credit Geber86