Cosigner on a Student Loan

Student Loans are the best kind of loans to get these days because the interest rates are regulated and are currently not allowed to go above a certain rate. Sometimes in order to get a student loan one must find a cosigner on a student loan. If a student does not have any credit or has bad credit most loans including student loans can be difficult to obtain. The bank or lender that is issuing the loans has to feel that the person is a good risk. A good risk is someone they feel who will pay back their loan payments on time and as scheduled. If you have established some credit such as paying off a car payment, paying on a gas card or a credit card, or have previously paid off a loan; then the bank or lender will consider you a lower risk. If you have had loans that you have not paid at all (defaulted on), or you are always late with payments, then that information is recorded on your credit report.

Then your credit report score becomes lower than the lender feels is a safe risk. They do not wish to loan out money that they are not going to get back. Educational loans take a long time to pay back usually and are easier for them to give if they know they will have consistent on-time payments. If you apply for a student loan and you are denied because of bad credit or no credit, you can reapply with a co-signer. A co-signer is someone who is willing to sign your loan and state that if you are not able to make the payments or start to pay off your loan late that they will be responsible for paying back your loan amounts that you haven’t. As a result being a cosigner on a student loan is not something that someone should do lightly. If a person cosigns someone’s loan, then a cosigner on a student loan must take over the loan when it goes into default.

If a cosigner on a student loan then does not pay the educational loan when it is in default, then they too will have a dark mark on their credit report. Non payment of a loan can really dump someone’s credit rating into the toilet. People strive to keep their credit numbers as high as they can, so one must carefully consider a few things before agreeing to be a cosigner on a student loan. First, what is your credit score, and is it high enough for the lender to accept your signature on the loan. In private loans the lower a person’s credit score is the higher the interest they pay. In an educational loan situation the bank or lender does not have this luxury.

Secondly, seriously consider how well you know the person you would be cosigning for? This is not something that one should do for someone they barely know for sure or for someone you do not think will have the capacity to pay back a loan on time after they have finished school. You should check out what careers in that field pay and if there are jobs available in the area where the person lives. Lastly, if you have the money to add this payment to your monthly output of money for your bills, payments, and loans etc. and do not feel that you are taking an undo risk in helping this student get on his or her feet then by all means be a cosigner on a student loan. School loans are safe loans to receive, but sometimes students with no credit or bad credit need to ask a cosigner for help.

IRS Tax Rules for Family Loans

Family loans are a good way of advancing funds to your adult children or close relatives at little risk. The recession and mortgage crunch of 2007 really increased the scrutiny by banks on people borrowing funds. Though the bank rates are low, banks have become extremely conservative and have heightened their underwriting rules. For this reason, it may be hard for your children to get a loan from the bank for their education, car, to start a business, or any other expenses. However, you may be at a better position to qualify for a loan and therefore, take out a loan for your child. The IRS does not have any rules that punish taxpayers who advance their children a loan, as long as the loan is advanced at market interest rates. The IRS will only require the lender to report the interest earned and pay income taxes on the interest payments only. The IRS uses the Applicable Federal Rate (AFR) as the minimum interest rate to apply for family loans with no further tax consequences. Therefore, a parent can advance funds to a child at a level interest rate of the AFR at the time of lending.

Below Market Loan Rules

If a parent chooses to advance a significant amount to a child at zero interest or at a rate lower than the AFR, he or she will still have to pay a tax on the interest differential. In other words, the parent or lender will be charged a tax on the interest that he or she would have earned if the AFR was applied to the loan. Therefore, whether a lender applies the AFR, zero interest rate or a rate below the AFR, they will pay the same taxes since the IRS will consider the taxes that should have been paid if the loan was charged at the AFR rate. To avoid the complexities of adjusting for a below-market loan, it is advisable to just charge the Applicable Federal Rate.

Take Advantage of Prevailing Low Rates

The AFR rates have really come down, especially in 2010 and 2011. The low rates enable a parent, friend, or close relative to advance funds at very low and friendly interest rates without any tax implications. For example, in April 2011, the Applicable Federal Rate for short term loans with a duration of less than three years was 0.55%. The rate for mid term loans (between 3-9 years) was 2.46%, and the rate for long term loans (more than 9 years) was 4.17%. Therefore, if a parent advanced a child a house loan to be repaid in 20 years for example, the child will repay the loan at an interest rate of 4.17% for the whole duration of the loan, irrespective of whether the AFR rises or not.

Demand versus Term Loans

The rule of applying a level AFR for a given loan throughout the duration of the loan only pertains to a term loan. Term loans are loans that are advanced with clear terms set at the start of the loan; the loan is to be repaid at a specified time or in specified installments at set dates. If on the other hand, the loan is a demand loan, then the IRS will require the lender to keep changing the interest rate with changes in the AFR. A demand loan is a loan with no set rules and the lender can demand repayment at anytime. A demand loan therefore, cannot take maximum advantage of prevailing low rates, as the applicable interest for taxation will rise as the AFR rises.

Zero Interest Small Loans

The IRS applies the AFR and the below-market-loan rules on only significant loans that are above $10,000.00. For loans below this threshold, the IRS does not require the lender to charge interest. Therefore, the loan can be distributed interest-free without any tax implications. However, if interest is applied to the loan, the lender will report the actual interest earned as income and pay taxes on it.