Cosigning a student loan is parenting's new financial hazard

Wife gesturing to husband over paperwork

Saying no to your children can be hard, especially when it’s for something you wish they could have.

But more Americans need to say no to their children when it comes to cosigning or taking out loans for college education.

That may sound cruel, but unless you’re very careful when taking on debt for your child’s education, you could be endangering your own financial livelihood — and you might not be doing your child any favors, either.

A growing number of moms, dads and even grandparents are getting stuck with a debt they can't hope to repay. In some instances, they wind up having their Social Security benefits garnished to cover the student loans their child or grandchild defaulted on.

Robert Reed, a certified financial planner with Reed Financial Planning in Columbus, Ohio, is one of many experts who believe parents need to make sure they don’t leave themselves overextended to help their children go to school.

"When it comes to retirement, what are you going to do — go live with your kid? You’re going to say, 'Congratulations on your graduation, do you have a spare room?' " says Reed, who also taught at Ohio State University and frequently counsels families on paying for college education.

The problem is part of a larger issue regarding the rising cost of higher education. Over the last decade, the average annual cost of tuition at public universities has climbed by 68%.

Despite a boost in educational aid by the Obama administration, student debt has soared. It passed $1 trillion last year, jumping by $300 billion in just three years, surpassing the nation’s total credit card debt.

The average graduate now leaves school owing $26,600, reports the Institute for College Access and Success. But many owe much more. Student loan debts of $100,000 or even more are not uncommon.

A third of that debt is held by people who are 40 or older, and roughly $42 billion is held by people over the age of 60, according to the Federal Reserve Bank of New York. The fastest-growing group of borrowers is aged 35 to 49.

While the Great Recession led some adults to take out loans and return to school to improve their chances of finding work, analysts believe that most of the educational debt taken out by older Americans has been for their children or grandchildren.

It’s come with hardship for many. Nearly 10% of the borrowers 60 or older were at least 90 days behind on making their loan payments during the first quarter of 2012.

The government is even withholding part of the Social Security check of about 119,000 Americans to pay for student debt. Under a law passed in 1996, the government can take up to 15% of your Social Security benefit beyond the first $750 to pay back the loans.

It's also very hard to escape student loan debt through bankruptcy.

These unpleasant facts are reasons why personal finance experts suggest you exhaust every other option — federal grants, local scholarships, even a cheaper educational institution — before becoming a cosigner for your child’s college loans.

“The combination of going to a for-profit college and taking out a private loan is a particularly big danger,” says Ellen Schloemer, executive vice president of the Center for Responsible Lending in Durham, N.C.

Private lenders will often provide a student more in loans for college than federal programs, but “the repayments terms are higher, you’re paying more on a monthly basis and they lack some of the other protections that the federal loans have,” she says.

And for-profit colleges “give very little in financial aid, so students have to get more loans, and their graduation rates can be so low, and it’s easy for a student to end up with a lot of debt and no degree, nothing that’s anything in the job market,” Schloemer explains.

As student debt has climbed, private lenders have increasingly sought to make sure the loans are backed by parents or other wage-earners. Ninety percent of private loans had cosigners last year, according to the U.S. Consumer Financial Protection Bureau, up from 68% five years earlier.

Yet Schloemer points out that 40% of students don’t exhaust their federal options before turning to private lenders. In part, this is because of the difficulty and uncertainty that can come with applying for aid, a process she says can be baffling.

But persisting is worth it.

“Do a lot of research so you know all your options before you sign on the bottom line,” Schloemer says. “Check out Pell grants (a federal aid program); check out federal loans; look for other scholarships. Private loans should be a last resort.”

Even if your child is going to an established public university or private nonprofit school, Reed cautions that you and your child need to take a realistic look at what he or she is likely to earn upon graduation when considering student loans.

“I love art, but if you’re going to get a degree in art history, are you going to get an art history job or are you going to be working at Starbucks, and how much are you going to be making at the end?” he says.

As a general rule, Reed doesn't like to see students running up college loan debt that exceeds their likely first-year income when they get out of college.

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Reed also cautions clients against shorting their own retirement savings in favor of putting money aside for college for children. Retirement generally lasts a lot longer than college, he notes.

A range of options is also available for financing college, including government student loans, while retirees generally have only their savings and Social Security.

“You can’t borrow to fund your retirement,” he points out.

When it comes to college, cosigning or taking out loans for your children’s schooling should be a last resort, Reed says.

“Frankly, I would be like a banker and say, ‘OK, what’s your plan? If you’re going to get money from us, you’re going to have to have a plan on how you’re going to pay it back.' ”

One of the first questions he'd ask is: "Do you know how much debt you’re in already, and how you’re going to pay that back?”

If these answers are vague or uncertain, then saying no may be the wiser course.

Not only could you save yourself financial trouble, you’ll also be saving your child from dealing with one of two painful options:

“I’m a big believer in a liberal education,” Reed says, “but you have to start with realistic expectations about what’s right for your kid and what you can afford.”