Cosigning a student loan? Not so fast
June 11, 2013
When Rachel Ramsey Cruze, daughter of anti-debt guru Dave Ramsey, was a senior at her Tennessee high school, she told her parents that she wanted to attend Auburn University (in Alabama) because her friends were going there. Does this conversation with a college-bound teen sound familiar?
Cruze's parents sat her down and said they would not pay almost double the price of University of Tennessee for her to cross the state line. They showed her the cost differences and said that if she wanted to go to Auburn, she could pay the difference herself.
"That opened my eyes," says Cruze, who is now 25. "I didn't want to pay $18,000 more per year myself, so I went to the University of Tennessee and now see how smart that was."
Not every parent has a similar discussion about college costs with their children. Some parents may even cosign the student loans necessary for a higher-priced education. But if that money turns out to be a poor investment, it can lead to headaches for students and parents alike.
Managing tomorrow's debt
Statistics from Collegeboard.org show that in 2010-11, 57 percent of public four-year college students graduated with debt. The average amount owed was $23,800.
"Student loan debt is largely unavoidable if parents cannot afford to pay for all college costs," says Mark Kantrowitz, publisher of Edvisors.com, a suite of college-planning websites. "So the trick is to minimize this debt. Show your child that every dollar borrowed costs $2 to pay back and how long it takes to pay it back."
Both Kantrowitz and Cruze stress that the primary purpose of college is to earn a degree that leads to a higher-paying job as soon as possible.
"Living it up or studying toward an impractical major for four years on borrowed money is not the lesson to teach your student," says Cruze. Both say that going to a high-price school is unnecessary for all but a few students.
If you are considering cosigning a loan that allows your child to attend a higher-priced school, these four warning signs should make you think twice.
1. Poor academics in high school
Because some states now offer lottery-funded scholarship awards for students who meet certain academic requirements, admissions at many less-expensive state colleges have gotten much more competitive. But if your student is ineligible because he or she doesn't meet those requirements, opting for a pricier private school that accepts lower academic standards may be a poor choice.
"Community college is the way to improve academics for students who don't meet four-year state college requirements," says Cruze.
2. Questionable future earnings
Kantrowitz offers this simple formula for determining how long it will take students to pay off their loans: If total student loan debt at graduation is less than the potential annual starting salary, loan repayment will be possible in 10 years or less. For larger loan amounts, repayment times can be significantly longer.
If the career's potential salary pales in comparison to the extra educational costs, borrowing more money may be a questionable option.
3. The need to consider less-attractive loans
Direct subsidized student loans from the U.S. Department of Education come with low interest rates and can often cover most in-state college costs, particularly if the student is able to secure other grants or scholarships. But if your child's educational bills force you to consider additional loans that have less-attractive terms than a direct subsidized loan, think carefully before choosing this route.
"Students never have to borrow all they are offered, especially if parents can pay some costs," says Kantrowitz. If you are forced to consider the federal Parent PLUS loan program or cosigning for a direct unsubsidized or private student loan at higher rates, the additional costs these loans impose may not be worth it.
4. A lack of certainty
A four-year college is not for everyone. Poor grades or a decision to drop out or transfer schools may result in a loss of paid-for credits, which can substantially increase college costs, says Kantrowitz. Some students are more inclined toward career paths that favor a technical certificate or two-year associate degree.
"Don't take a year off to save money," Kantrowitz says. "It's better to complete the degree to get to that higher-paying job quicker, especially in today's unstable economy."
Think before you sign
Parents often think that cosigning simply means they are helping their child get a loan, but a cosigner is equally obligated to repay the debt if there is a default.
"Parents need to protect their own credit," says Kantrowitz. "Realize that 'cosign' means 'your loan,' which can use up your own credit resources. Also, I never advise even considering a home refinance, using credit cards or borrowing from retirement savings to pay for college."
Because they are the ones who will sign the checks, parents ultimately have control over how much they'll help their children, says Cruze.
"Think long term," she says. "When your student graduates and gets their first job, and may be considering a mortgage loan, they will be so thankful not to be burdened with payments for student debt that might have been avoided by working hard and taking the least expensive route through college."