Even in the best of circumstances, cosigning a student loan can hurt the cosigner — we see this most often when the debt hurts the cosigner’s debt-to-income ratio (DTI).
If the borrower misses a deadline or makes a mistake, the cosigned loan can hurt the cosigner’s credit score.
Unfortunately for cosigners, DTI and credit score are the two most important factors creditors use when evaluating mortgage, car loan, and credit card applications.
Today we will examine how cosigned student loans impact the cosigner’s credit score and DTI. We will also look at some strategies to minimize or eliminate this impact.
Cosigned Debt is Your Debt
In most cases, lenders and creditors will treat cosigned debt as your debt when evaluating applications.
Your credit report shows a total balance, monthly payment amount, and repayment history. In some cases, it doesn’t show that the loan is cosigned or that the cosigner is not the principal borrower.
Lenders don’t care. As far as a potential creditor is concerned, you may have to start making payments on the debt. In most cases, they assume that you will be making payments on the debt.
Because almost all lending decisions are made using an automated computer algorithm, cosigners don’t get to explain themselves or demonstrate that the primary borrower is responsible and able to make payments.
One Possible Exception: Some mortgage lenders will exclude cosigned debt from mortgage applications. However, the cosigner usually must show that the primary borrower can make payments independently and has been doing so for at least a year.
If the primary borrower is still in school or on a deferment, the cosigned debt will almost certainly be treated as the cosigner’s own debt.
Debt-to-Income Ratio (DTI) Damage from Cosigned Loans
Because most cosigned loans are “counted against” the cosigner, the most common negative consequence is that it hurts the cosigner’s debt-to-income ratio, usually shortened to DTI.
An applicant’s DTI is critical when applying for a mortgage, car loan, or credit card. Lenders often deny applications if the high monthly bills on your credit report eat up a large portion of your yearly income.
For example, mortgage lenders like to see a DTI below 41%. If you have a modest income and cosign large student loans, getting approved for a home loan will be tough.
Credit Score Risk Only Impacts Some Cosigners
Things are a little less bleak on the credit score side of the equation.
The big risk to a cosigner’s credit score is if the borrower fails to make payments.
If the borrower doesn’t make payments on the cosigned loan, the cosigner has two options:
- Start making payments on behalf of the cosigner.
- Live with the damaged credit score and other fallout from failing to make payments on the loan.
It’s worth noting that the cosigner is legally obligated to pay if the borrower fails to make payments. The credit score damage is just the beginning of the issues if the payment is unaffordable for both the borrower and the cosigner.
Removing Cosigners Can Fix DTI and Credit Score Issues
Given all of the risks with a cosigned loan, it isn’t a surprise that many cosigners want to be removed from the loan.
Some lenders even advertise a cosigner release program to entice people to use their services. Sadly, the cosigner release programs are more myth than reality, according to the Consumer Financial Protection Bureau.
Lenders have every incentive to deny the release application. If they grant the release, they only have one person legally responsible for the loan. For this reason, many lenders require the primary borrower to have made at least a year of payments AND pass an additional credit check.
However, if the borrower has a great interest rate on their loan and has built up a strong payment and credit history, seeking a release is a worthwhile effort.
Once the cosigner release is granted, the debt falls off the cosigner’s credit report, solving the DTI issue and preventing future credit score problems.
Cosigner Release Guide: A cosigner release isn’t the only way to remove a cosigner from a loan. Several other strategies are available to remove the debt from the cosigner’s credit report.
Steps When Cosigner Removal Isn’t an Option
If the lender won’t approve the cosigner release, refinancing the debt is a commonly used shortcut.
The process is relatively simple: The borrower applies to refinance their private student loan. If approved, the new lender pays off the old loan, and the borrower begins repayment on a new loan with new terms.
If the cosigner isn’t on the new loan application, they are free from the debt.
Steps to Take if the Borrower Can’t Qualify to Refinance
The refinance option is great when the primary borrower has finished school and begun loan repayment. Refinancing will be much more complicated if the borrower is still in school or struggling financially.
In this instance, cosigning a second time could make sense.
By going this route, the cosigner’s legal responsibility hasn’t changed. However, refinancing might offer lower payments and/or a lower interest rate.
If the refinanced loan has a dramatically reduced monthly payment, the damage to the cosigner’s DTI is likewise reduced. For example, refinancing a 5-year loan into a 20-year loan could result in significantly lower monthly payments.
The downside is that interest spending may increase. However, the borrower can still pay extra to pay off the loan as initially planned; they just have the flexibility of a lower monthly payment.
As the primary borrower’s finances improve, they could refinance a second time to remove the cosigner completely.
As of May 2023, the following lenders advertise the lowest interest rates for 20-year fixed-rate refinance loans: