How Student Loan Co-signing Works

If you're a prospective college student, there are myriad reasons why you might need a co-signer. Even if you have excellent credit -- which is highly unlikely, as most incoming college freshmen simply haven't had enough time or financial experience to build up creditworthiness -- you still might want a co-signer so you can get a lower interest rate.

In a lender's eyes, a co-signer adds legitimacy and lessens the risk of your loan. After all, banks are in business to make money, so adding another person (preferably someone older and with a decent credit history) to fall back on in case you default greatly increases the chances that banks will see a return on their investment -- namely, you. Therefore, they can afford to give you a lower rate because they're more certain they'll be repaid. A drop of a few percentage points will save you thousands of dollars over the life of the loan.

So, who could help finance your future? If you're fresh out of high school, your parents are always a safe bet, but you have to be careful. Times are tough, and if mom and dad have a less-than-perfect credit history, you'll probably want to look somewhere else. Adding a co-signer who is statistically unlikely to pay will only hurt your cause, not help it. If your folks are out, try pleading your case to a more financially stable relative or even a trustworthy friend. At the end of the day, it doesn't matter to the bank who your co-signer is. As long as you get a reliable person with a good credit history to sign on to your debt, you should be OK.

However, you're not going to convince any old Joe Schmo to help finance your college education. It's a huge responsibility, even if you never miss a payment. Your co-signer is accepting complete liability of your loan; as a result, until you pay off the debt, it will limit his or her borrowing potential and will probably result in higher interest rates on other loans and purchases made on credit. If you have a financially stable older brother, for example, who plans on buying a house or a pricey car in the near future, he'll probably be hesitant about taking on this expensive burden, even if he trusts you to repay it.

A number of things will happen to you and your co-signer should you default on your student loan, regardless if you finished college or not. Along with car repossessions and home foreclosures, a defaulted student loan is one of the most serious credit no-nos a person can make. Student loans -- both federal and private -- are, along with taxes and child support, nondischargeable, meaning that not even bankruptcy can get rid of the debt [source: Dugas].

If you and your co-signer go 270 days without making a payment, you're in default. The first thing you'll probably notice is the downgrade in your credit. Anyone who pulls your credit will immediately see the default, so you can forget buying a house, car or other big purchases on credit for at least the next seven years (the time it takes for bad debt to fall off your credit report). If you do manage to acquire some form of credit, you can count on paying exorbitant interest rates, often 40 percent or higher [source: Fragala].

Defaulting on your student loans can also affect your job search and living situation. Many employers check the credit of potential employees, and your default is going to stand out like a big, red "F" on a grade school test. The same is also true of rental agencies, so don't plan on moving anytime soon.

Collection agencies won't wait around for you to find the money for payments; they'll eventually take you to court. They can garnish your wages and put liens on your property, and the added litigation costs will be added to your debt, along with interest and penalties.

Of course, the same things happen to your co-signer, but collection agencies may pursue him or her more seriously, given that he or she probably has more means and assets than you do and is likelier to belatedly cough up the money for your education. It's doubtful that your co-signer is going to appreciate being put into this situation, and depending how late you are with your payments, his or her credit can still be ruined, even if he or she pays off the balance of your loan.

The good news, however, is that many lenders will allow you to apply for a delayed payment or forbearance -- minus interest -- on your loans if you're hard up. Even if you don't qualify, lenders may be willing to renegotiate payment terms with you so you don't go into default. But if your lender demands immediate payment, make sure your co-signer pays the bill. Both of you are legally responsible for the debt, and you'll share the consequences of delaying the payment.