5 Things Parents should consider before Co-Signing for their Child
Considering co-signing for your child? As my daughter is venturing off to college and we strategize for ways to pay for it, I thought this article was most enlightening to share with all. Co-signing for a loan is serious business and necessarily affects your credit rating and your debt-to-income ratios.
Co-signing can have serious ramifications when trying to buy your next home. If you choose to co-sign for a loan of any kind, my advice is to have the bill sent to you directly. Have your co-signer pay you and you pay the vendor. At least then you know if the debt has been paid on time and you can protect your own credit. Remember, if the bill is paid late or not at all, both co-signers’ credit is damaged!
As a parent, you may have the best intentions when co-signing for a child on a loan, a credit card or an apartment lease. But doing so opens you up to risk. So if you’ve been asked (or are thinking about offering) to co-sign for a son or daughter, make sure you know these five things before you say yes.
- Why can’t your son or daughter qualify on his or her own? Does the bank know something you don’t know? Obviously, if your son or daughter is young and doesn’t yet have a credit history (or much of a work history), it’s understandable that lenders may not be willing to approve a loan or a credit card. In that case, co-signing gives your child an opportunity to buy his or her first car or home and establish a credit history. But if your child is older, has a job, lives on his or her own, or has obtained credit in the past, there’s a reason that an individual can’t qualify for a loan on his or her own. Find out what it is before you decide to co-sign. If the bank sees red flags, you might want to heed them, too.
- You’ll be on the hook if payments are missed or the loan defaults. Be prepared for the worst-case scenario. The 2016 creditcards.com survey showed nearly 40 percent of co-signers had to pay some or all of a loan or credit card bill because the borrower did not. So make sure you have the financial means to step in and make payments or pay off the loan if necessary. To be on the safe side, ask your financial representative to show you what the impact would be on your own financial plan if you had to assume responsibility for the loan. And if you can’t absorb the expense without compromising your future financial security, you may want to think twice about co-signing for a loan and taking on the potential liability.
- Your own creditworthiness will be impacted. The loan or credit card balance will be reflected on your credit report as if you obtained it for yourself. So if all goes well and payments are made on time every time, your credit score may actually improve as a result of having the debt in good standing on your record. If payments are missed, however, your credit score will suffer. And in either case, co-signing for a loan (or having an additional credit card balance) will increase your debt-to-income ratio, which may make it harder for you to borrow money. If you have a high level of debt in relation to your income, lenders may view you as someone who’d have trouble making payments.
- You’re typically tied to the debt for as long as it’s owed. Co-signing isn’t something you can walk away from easily. Some loans (private student loans, mostly) have programs that will allow a co-signer to be released from his or her obligation after a certain number of consecutive on-time payments have been made. But in most other cases, such as car and mortgage loans or credit card balances, it’s not that simple. You’ll likely be tied to the loan until it’s repaid unless your child refinances or consolidates the debt under his or her own name. So if you choose to co-sign, monitor the loan activity closely. Get copies of the monthly statements or obtain access to the account online so you can see for yourself that payments are being made on time. The last thing you want is for missed payments to go unnoticed since you would ultimately be held responsible for the loan.
- You have options. If the risk of co-signing isn’t something you’re comfortable with, there may be other ways you can help. If the goal is to help your son or daughter establish a credit history, consider a secured credit card. With as little as a few hundred dollars down as a deposit, many banks or credit unions will issue your child a major credit card—with a credit limit based on the deposit—which they can use just like any other credit card. If your goal is to help your child make a significant purchase, you could simply loan the money directly. It obviously wouldn’t help that child establish credit, but it also wouldn’t jeopardize your own credit reputation if he or she missed a payment. (It may, however, be disappointing.)
If you do choose to go ahead with co-signing a loan for your child, there’s one additional step you might want to take to protect yourself from risk. Make sure your son’s or daughter’s ability to make loan payments is protected in case he or she becomes ill or injured. Learn if he or she has group disability insurance coverage through work, and if so, determine whether the benefit would be enough to cover the loan payments. If not, the coverage could be supplemented with an individual policy. An individual disability policy could also be used to provide income protection if your child doesn’t have coverage through work. You may even consider taking out a small life insurance policy on your child. As the beneficiary, the funds you receive from the death benefit can help pay the loan in the event of his or her untimely death.
Co-signing a loan can be a great way to help your child establish a credit history and, potentially, make a first significant purchase of a car or a home. But remember, co-signers take on risk. Make sure you understand what’s at stake before signing on the dotted line.
Initially Published 7/17/2017