It's relatively easy to cosign a student loan for a child or other family member, but getting off the hook is another matter. Lenders rarely release co-signers from their obligation to repay that loan should the borrower be unable to do it.
A new report by the Consumer Financial Protection Bureau (CFPB) finds that 90 percent of the private student loan borrowers who asked to have their co-signer released from the loan had that request rejected.
Why does this matter?
As long as you're a co-signer, you're a co-borrower, equally responsible to repay the debt and for any missteps the borrower makes. Their actions, such as missing payments, could damage your credit history as well as theirs.
The borrower is also at risk. If their co-signer, typically a parent or grandparent, dies or files for bankruptcy, that's likely to trigger an "auto-default" clause that would require an immediate repayment of the entire loan amount.
"We're concerned that the broken co-signer release process is leaving responsible consumers at risk of damaged credit or auto-default distress," said CFPB Director Richard Cordray, in a statement. "Responsible borrowers and their co-signers should have clear information and standards for releasing the co-signer if the time is right."
CFPP study finds problems
The CFPB analyzed 3,100 private student loan complaints and 1,100 debt collection complaints and found "problematic industry practices" that may be disqualifying some student loan borrowers from having their co-signer taken off the loan.
According to the CFPB report:
- Borrowers are often left in the dark with little information on the criteria needed to obtain a co-signer release or why their request was denied.
- Some companies penalize or disqualify borrowers who prepay their loans and are in good standing or who accept an offer to postpone payment through forbearance. These policies can permanently prevent a co-signer release for the life of the loan.
- Potentially harmful clauses, such as the "universal default," are often hidden in the fine print.
The universal default clause allows a financial institution to trigger a default on that student loan if the borrower or co-signer is not in good standing on a separate loan with the institution (such as a mortgage or auto loan), that is unrelated to their payment behavior on the student loan. The CFPB says these clauses can increase the risk of default for both the borrower and co-signer.
CFPB's Student Loan Ombudsman Rohit Chopra, who prepared this report, called on student loan companies to "clean up contracts with surprises buried in the fine print" and provide borrowers and their co-signers the service they deserve.
The report suggests practices that would benefit both consumers and the industry. These include providing specific requirements that a borrower need to meet in order to get a co-signer release and notifying borrowers when they qualify for releasing a co-signer, such as making a certain number of on-time payments.
A word of warning
Mark Kantrowitz, a student loan expert and publisher of the website Edvisors.com, says the CFPB study shows just how difficult it is for co-signers to get released from their obligations on a private student loan.
"Lenders want to get paid and if they have any doubts about the student's ability to repay the debt, they're not going to go from a situation where they have two fish on the hook - the borrower and the co-signer - down to one," Kantrowitz said. "The only time they will release a co-signer from their obligation is when they have very high confidence that the primary borrower is going to repay the loan with no problems."
Lenders require anywhere from 12 to 48 consecutive on-time payments and a good credit record to qualify for that co-signer release. One late payment -- not 30 days late, but one day late -- resets the clock.
Most private student loans require a co-signer. Parents and grandparents need to remember that doing this is a very serious undertaking. You are legally agreeing to be responsible for repaying that debt.
Kantrowitz suggests asking yourself this question: "How much do you trust your child to manage your credit responsibly? Remember, by co-signing, you're giving them the keys to your financial future and they have the ability to ruin your credit."
You'll find a list of ways to increase your odds of getting a co-signer release on the Edvisors website.
To help borrowers overcome obstacles to a co-signer release, the CFPB published a set of sample letters for private student loan borrowers and their co-signers to send to their private student loan servicer.