When you co-sign on a loan, you’re telling the lender that you will pay the loan if the main borrower does not. The penalties for failing to keep the loan up to date can include a hit to your credit, the loan going into collections, and a possible court judgment against you.
The truth is, even though you’re not the main borrower, you’re still completely responsible for repaying the loan if the borrower fails to do so. And, when you co-sign on a student loan, you’re taking on an obligation that is generally not dischargeable in bankruptcy.
Before you agree to take on a co-signer’s obligations, you should be very sure that the main borrower can and will pay off the loan on time. It’s worth a sit-down discussion. Make sure they understand how important it is to make every payment on time. Make sure they understand how both their credit and your own could be damaged by even a single late payment. Make sure they agree to contact you when or if something happens that could make them miss a payment.
Also, make sure they plan to get you off of the loan as soon as possible. This generally requires an improvement in their financial situation and/or credit rating, because they need to be in a position to qualify for the loan on their own. They should try to remove you from the loan or to refinance the loan with another lender after 12 to 48 on-time monthly payments.
But life happens. The borrower could lose their job. They could become ill. They could become overwhelmed with other financial issues. You need to be prepared.
Capitalization during school can cause the loan amount to grow significantly
When people borrow through subsidized federal student loan programs, they typically don’t have to make payments while they are in school full time. During this period, the government pays the interest, keeping the cost of borrowing low.
If you co-signed on a student loan, however, it’s almost certain that it was an unsubsidized loan from a private lender. These loans work differently. Although full-time students are not expected to pay while they’re in school, the interest is rolled into the principal balance on the loan. This makes the loan grow larger by graduation day. To prevent that, students are urged to make interest payments even while they are full-time students.
What choices do you have once the student loan has gone unpaid?
As we mentioned above, student loans are generally not dischargeable in bankruptcy. That said, bankruptcy may still be a good option for you if you aren’t in a position to pay off the loan.
Filing for Chapter 7 bankruptcy will wipe away other debts such as credit card bills and medical bills. The relief from these other obligations could give you the ability to repay the loan you co-signed on. If you don’t want to risk your home in a Chapter 7, talk to your bankruptcy attorney about whether you can reaffirm that debt.
Chapter 13 bankruptcy involves setting up an affordable repayment plan for all your debts, including the student loan. These repayment plans last between three to five years and are based in large part on your ability to pay. Once you’ve successfully completed the plan, any remaining debt could be wiped away.
A good bankruptcy attorney can help you assess your situation and provide you with options to choose from. Weigh the pros and cons of each option and make the choice that best meets your needs.