The credit bubble has burst. Banks that once sang their siren songs to anyone with a pulse are now clinging to their cash reserves with a tight fist. Tougher lending standards, coupled with a troubled and unstable job market, have made it difficult to obtain credit. This is particularly true for those just starting out. It is becoming more common for banks to ask for a co-signer on mortgages, auto loans, credit cards and student loans. Even though we may want to help a family member or close friend, the risks are enormous. With a stroke of the pen, your signature can destabilize your entire financial future.
What Being a Co-signer Really Means
Most people believe that being a co-signer is like being a reference on a job application. It is not. A co-signer is a co-owner. The debt is your debt, the liability is your liability, and you are required to repay it. If the borrower does not make payments, you may have to pay the full amount plus late fees and collection costs. Depending on your state laws, the creditor can collect this debt from you before first trying to collect from the borrower. Collectors will go after the person with the best chance of recovery. That will be you! In addition, being a co-signer affects your own ability to get financing. Even in the best case scenarios where the borrower pays consistently and on time, the loan is still viewed as your loan and is factored into your debt-to-earning ratio. This can decrease the amount you are eligible to borrow or increase your interest rate. Finally, the Federal Trade Commission has reported that three out of four co-signed loans end up being paid by co-signers. This means that by simply signing your name on documents, you have a seventy-five percent chance of being asked to repay that debt. If you are still willing to gamble with your credit score and financial future, it is prudent to establish some guidelines before taking this risk.
Mortgages
It is never a good idea to co-sign a mortgage. During the thirty year loan period, it is realistic to expect the borrower will experience one of life’s many setbacks. Whether it is job loss, injury, illness, divorce, or even death, chances are great that you will be called upon to make a payment. If the borrower needs a co-signer because of inadequate income, the answer should be flatly no. Encourage them to be more realistic. A starter home is a good way to build equity that can later be applied to their “dream home”. If the mortgage was denied due to lack of credit history, co-signing a low balance credit card and making regular and consistent payments for a year can help give them the necessary credit background needed to qualify for a mortgage on their own. Alternatively, assisting with the down payment could be a great way to help a borrower qualify for a mortgage. It also provides tax benefits and does not tether you to their debt for years to come. Each tax year (2022 figures) you can gift up to $16,000 to an individual, or $32,000 if your spouse gifts as well. In addition, this amount can be doubled when gifting the homeowner’s significant other in the same manner. If you have the money, this may be a better way to keep yourself out of harms way and mitigate potential loss.
Credit Cards
Many parents co-sign their children’s first credit card. If you choose to do this, do so in a way that provides an opportunity to teach good credit skills. First, make sure that the credit card has the lowest balance possible. This will alleviate the potential of being stuck with a large debt and keep their monthly payments reasonable. Second, do not increase the credit limit if they max out the card. Finally, after credit has been established, close the existing account and open a new one just in their name.
Student Loans
With the skyrocketing cost of higher education, many parents are being asked to co-sign student loans. If your child is a good student and demonstrates both maturity and responsibility, you may want to consider co-signing a loan in order to secure a lower interest rate. However, before you sign, take into consideration their field of study and what will be realistic for them to pay back. Be careful to only apply for loans that allow you to be released from the loan after a good repayment history has been established. Also, remember that student loan debt never goes away! Unlike other loans, student loans can cause a lifetime of problems. They cannot be discharged through bankruptcy, and money can be taken from wages, tax refunds and social security payments after retirement. Delinquency can also make you ineligible for Federal employment and cause certain professional licenses to be revoked. Being a co-owner of a delinquent student loan could derail your financial future, retirement plans and credit. Make sure you can afford this.
Many financial professionals will advise you to never be the co-owner of another person’s debt. If you still want to proceed, make sure you take the proper steps to protect your financial future as much as possible. If you co-sign a mortgage, make sure the home is remortgaged as soon as the borrower can handle the debt on their own. On any type of co-signed loan, ask lenders to keep you informed of any late or missed payments. If you are asked to co-sign either a large or long term debt, it is certainly reasonable to request that a term life insurance policy be taken out in the amount of the debt. As uncomfortable as it is to think about, tragedy can occur, and the debt will still be there even if your loved one is not. Remember, the moment you sign your name to another person’s loan, your financial position changes. Take this decision very seriously and proceed with caution!
Contact us for a full evaluation of your debt and financial situation so you can fully understand the risks of these and other major financial decisions.