Co-Signer and No Co-Signer Loans

A co-signer is a second party who guarantees to repay the loan and usually becomes involved when the primary borrower has no or a poor credit history.

Students often have few or no credit cards, no car loans and very rarely a home mortgage loan. As a result, they have little or no credit history at all. And, as is the case with many of us in our youth, they may have made some unwise choices. They may have gone beyond what they could repay on a credit card and even been irresponsible about making payments.

That lack of credit history or, worse, actual late payments or defaults can easily put a potential borrower into the high risk category. Loan officers, even in Federal student loans programs, will often look at that with a cautious eye. Loan applications may be denied, or in borderline cases a higher interest rate is charged to offset the risk and compensate for higher default rates.

To counteract that lack of credit history or poor record, borrowers can and usually should obtain a co-signer. In the average case that will be one or both parents. Loan officers will look then at the parent's FICO score, outstanding debt to income ratio, repayment history and other standard factors in deciding whether to grant the loan.

At the same time, the credit quality of the parents becomes the primary factor for deciding the interest rate assigned. Those with a superior credit history typically get the best rates, while those with lower FICO scores usually pay a higher rate. The difference can amount of a substantial sum over the standard repayment period of 10 years.

For example, one popular co-signer program shows a 4% program paying $5,489 in interest over the life of the loan, rising to $10,647 at 6%. A 2% difference doesn't sound like much, but given contemporary borrowing amounts and compounding, such a scenario is not unrealistic.

For example, it isn't uncommon these days for students and parents to borrow as much as $100,000 to finance an undergraduate education. Even if interest is paid right away (so it doesn't accumulate while the student is in school, adding to the total to be repaid), interest at 6.8% is almost $567 per month. The annual interest total is almost $6,600.

Lowering that interest rate to 5% (the official amount for a need-based Perkins loans) reduces those numbers to $417 and $4,820. And keep in mind that the example assumes that repayment begins immediately. Deferring repayment until six months after leaving school, the most common scenario, will result in much higher amounts unless the interest is deferred or subsidized.

Using a co-signer with good credit can substantially lower the total interest paid, along with improving the chances of getting desirable loan features. Run through some sample scenarios by using a loan calculator such as the one from Bankrate.com.