For families searching for ways to pay for college, the federal Direct Loan for students may seem on the surface to be the best option: This loan requires no credit history check, and for borrowers struggling to repay their debt, the loan program offers income-based repayment options. Further, the current interest rate of 4.53%, which everyone gets, is lower than you’ll find elsewhere.
But the Direct Loan has a borrowing cap of about $5,500 for freshmen and typically $31,000 for all their undergraduate years.
One of the alternatives that families turn to when they need to borrow more is a private college loan. The interest rates on private loans, however, are almost always higher and are tied to borrowers’ credit scores. They don’t offer the income-based repayment options.
When I looked into private college loans from some lenders in early 2020, the fixed APR ranged from 4.26% to as high as 13.63%. The minimum credit score to qualify for any private loan is often in the mid-600s, and getting the lowest interest rates will be impossible for the vast majority of borrowers.
I’ve heard from parents who don’t want to borrow a large amount for college but are willing to let their children take on huge debt via private loans if they are passionate about attending an expensive school.
I always thought that was a callous and reckless position. Teenagers typically have no concept of the hazards of large debt, how it could ruin their financial lives and limit their career options. Eighteen-year-olds are focused on attending their dream college and can’t resist that shiny object unless adults step in and say “no.”
To be sure, students aren’t the only ones responsible for these loans.
To qualify for a private loan, nearly all undergraduate borrowers will need a co-signer. A parent who co-signs the loan will be legally responsible for the payments if the child stops making them. One or two missed payments could not only damage the credit score of the primary borrower, but also of the co-signer. And the co-signer could be oblivious to what’s happening. That’s a frightening proposition.
A 2019 report by AARP found that 25% of private student loan co-signers, who were 50 years or age or older, had to make at least one loan payment because the student borrower failed to do so.
Private loans do have a safety hatch for adult co-signers. These loans typically contain provisions that allow a co-signer release if certain requirements are met, such as making a certain number of on-time, monthly payments.
The survey that AARP conducted, however, discovered that among co-signers who were 50 years of age or older, 71% didn’t know they could request being removed from the loan.
While a co-signer release provision will seem to make a private loan less risky, the reality is quite different. Student loan experts said that co-signer release is extremely rare.
“It’s near impossible to get co-signer release on your loans. In fact, in a decade of helping people with their loans, I’ve never seen it successfully happen,” said Robert Farrington, a student loan expert at The College Investor.
While almost all lenders advertise a co-signer release, very few advertise the requirements. It is also hard to find the co-signer release requirements on lender websites, said Adam S. Minsky, a student loan lawyer in Boston.
“The underlying loan contract generally governs cosigner releases,” Minsky said, “and often the language in these contracts is fairly broad and favors the lender.”
When shopping for private loans, it does make sense to see if a lender will provide a loan discharge for disability or death, Farrington advised. While it remains rare, more private lenders are offering this provision. The federal Direct Loan and federal Direct PLUS Loan for parents provide this provision.
What also makes sense if your client plans on becoming a co-signer on private loans is to take out a term life insurance policy on the student borrower for the life of the loan.
The good news is that these term policies will be inexpensive. Here are two examples that John Barada, a certified college planning specialist at Strategies for College in St. Louis, pulled for me:
18-year-old male student
$50,000 term life policy
Yearly premium: $94.50
$100,000 term life policy
Yearly premium: $88
Parents will probably be less enthusiastic about letting their children borrow through private loans when they know the financial risks that they must take as well.
Lynn O’Shaughnessy, a nationally recognized college expert, offers an online course – Savvy College Planning - exclusively for financial advisors. Click here to get Lynn’s guide, Finding the Most Generous Colleges.