Risks to Consider Before Co-signing Your Kid’s Mortgage

Homeownership is a cornerstone of the American Dream for most, but many millennials are finding it difficult to afford to buy in.

Overall, millennials are still far behind in homeownership compared to previous generations were at their age. Only 39.1% of millennials lived in a home they owned in 2016 compared with 63.2% of Gen Xers, according to an analysis by Trulia Economist Felipe Chacón.

Student debt and stagnant incomes could share some of the blame. Millennials earn 78.2 cents for every dollar a Gen Xer earned at their age, Chacón found. Nearly half of millennial homebuyers report carrying student loan debt, according to the 2016 National Association of Realtors Home Buyer and Seller Generational Trends survey. They carry a median loan balance of $25,000.

Loan officers have to take a borrower’s total debt picture into account when running their application, and it’s become increasingly hard to qualify for a mortgage with a vast amount of student debt.

When they can’t get approved for a mortgage, it’s common for homebuyers to seek out a co-signer for their loan. Often, that person is a parent.

Co-signing a child’s mortgage loan is a serious decision, and parents should weigh all of the risks before making any promises. We asked financial experts what risks are worth worrying about to help clear out the noise.

  1. You’re on the hook if your kid stops making mortgage payments

When you co-sign a loan, you agree to be responsible for payments if the primary borrower defaults. If you’re expecting to retire during the life of the mortgage loan, co-signing is an even larger risk, as you may be living on fixed income.

Dublin, Ohio-based certified financial planner Mark Beaver says he’d be wary of a parent co-signing a mortgage for their adult child. “If they need a co-signer, it likely means they cannot afford the house, otherwise the bank wouldn’t require the co-signer,” says Beaver.

By co-signing, you effectively take on a risk the bank doesn’t want. And the list of potential scenarios in which your child may no longer be able to afford their house payments can be vast.

“What if your daughter marries a jerk and they get divorced, or he/she starts a business and loses money, or doesn’t pay their taxes. The risk is ‘what can happen that can make this blow up,’” says Troy, Mich.- based lawyer and Certified Financial Planner, Leon LaBrecque.

Bottom line: If you wouldn’t be able to comfortably afford the payments in case that happens, don’t co-sign.

  1. You’re putting your credit at risk

A default isn’t the only event that could negatively affect your finances. The mortgage will show up on your credit report, too, even if you haven’t taken over payments. So, if your child so much as misses one payment, your credit score could take a hit.

This may not be the end of the world for an older parent who doesn’t anticipate needing any new lines of credit in the future, Beaver says, but it’s still wise to be cautious.

You might think your child is ready to become a homeowner, but a closer look at their finances may reveal they aren’t yet that financially mature. Don’t be afraid to ask about their income and spending habits. You should have a good idea of how your child handles their own finances before you agree to help them.

“Sure, we don’t want to meddle and pry into our children’s business; however, you are putting yourself financially on the line. They need to understand that and be open about their own habits,” says Andover, Mass.-based Certified Financial Planner John Barnes.

  1. Your relationship with your child could change

Co-signing you child’s mortgage is bound to change the dynamics of your relationship. Your financial futures will be entangled for 15 to 30 years, depending on how long it takes them to pay off the loan.

Seal Beach, Calif.-based certified financial planner Howard Erman says not to let your feelings get in the way of making the correct decision for your budget. Think of how often you communicate and the depth and strength of your relationship with your child. If saying no might create serious tension in your relationship, you likely dodged a bullet.

“If your child conditions their love on getting money, then the parent has a much bigger problem,” says Erman.

Similarly, you should consider how your relationship would be affected if somehow your child ends up defaulting on the mortgage, leaving you to make payments to the bank.

  1. You might need to let go of future borrowing plans

Co-signing adds the mortgage to the debts on your credit report, making it tougher for you to qualify for additional credit. If you dreamed of one day owning a vacation home, just know that a lender will have to consider your child’s mortgage as part of your overall debt-to-income ratio as well.

Although co-signing a large loan such as a mortgage generally puts a temporary crimp in your ability to borrow, keep in mind you may be affected differently based on the dollar amount of the mortgage loan and your own credit history and financial situation.

How to Say “No” to Co-signing Your Child’s Mortgage

There is a chance you’ll need to deny your child’s request to co-sign the loan. If you feel pressured to say yes, but really want to say no, Barnes suggests you say no and place the blame on a financial adviser.

“Having [someone like] me say no is like a doctor telling a patient he or she can’t run the marathon until that ankle is healed. It is the same principle,” says Barnes.

He advises parents facing the decision to co-sign a loan for a family member to meet with a financial planner to analyze the situation and give a recommendation for action.

If you choose to take the blame yourself, you may want to take the time to explain your reasoning to your child if you feel it’s warranted. If you said no based on something they can change, give them a plan to follow to get a “yes” from you instead.

LaBrecque suggests that parents who want to help out but don’t want to take on the risks of co-signing instead give the child a down payment and treat it as an advance in the estate plan. So if you “gift” your kid $30,000 to make the down payment, you would reduce their inheritance by $30,000.

The “gift the down payment” method grants you some additional benefits too.

“[The] method has a more positive parent/child relationship than the potential awkwardness of Thanksgiving with the kid(s) and late payments on the mortgage. Also, the ‘down payment gift’ is a quick victory. The kid’s now made their bed with the mortgage; let them sleep in it,” says LaBrecque.

Similarly, you could choose to help your child pay down their debts, so they’ll be in a better position to get approved on their own.

If you must say no, try to do so in a way that will motivate them toward the goal rather than deflate them. Erman recommends lovingly explaining to your child how important it is for them to be able to achieve this success on their own.

How to Protect Yourself as Co-signer

The best way to protect yourself against the risks of co-signing is to have a backup plan.

“If a child is responsible with money, then I generally do not see a problem with co-signing a loan, provided insurance is in place to protect the co-signer (the parent),” says Barnes.

He adds parents should make sure the child, the primary borrower, has life insurance and disability insurance in case the widowed son or daughter-in-law still needs to live in the home, or your child becomes disabled and is unable to work.

The insurance payments will also help to protect your own credit history and future borrowing power in case your child dies or becomes disabled. But these protections would be useless in the event your child loses their job.

If that happens, “insurance will not pay your bill unfortunately, so even if you are well insured, budgeting is vitally important,” Beaver says.

If you choose to take on the risk and co-sign, Barnes says to make sure you and your child have a plan in place that details payment, when to sell, and what would happen if your child is unable to make payments for any reason.

Additionally, LaBrecque recommends you get your name on the deed. Don’t forget to address present or future spouses. Ask your lawyer about having both kids sign back a quit-claim deed to the parent. If you get one, he says, you’ll be protected in case the marriage goes south, or payments are made late, because you would be able to remove a potential ex off the note.

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Which Credit Cards Allow a Co-Signer (And What to Do If You Can’t Get One)

There may be no greater misconception in the financial world than the notion that “anyone” can get a credit card. Getting approved for a traditional credit card is no sure thing. In fact, a recent study by the Consumer Financial Protection Bureau found the approval rate for general-purpose credit cards to be less than 40%.

All of which means many borrowers, particularly those who are routinely denied new credit, need another way to access credit if they want to build or improve their credit history. Finding a reliable co-signer is one option. The concept is simple. If you can’t get approved for a traditional credit card on your own, you find a co-signer with a stronger credit profile who is willing to agree (in writing) to bear full responsibility for the card’s balance should you not pay, thus easing the lender’s concerns.

Joint accounts work much the same way, but there’s a big difference: joint account holders have charging privileges, meaning they can use the card as they want, whereas co-signers usually do not. At the end of the day, whether someone is a co-signer or a joint account holder, they’re every bit as liable as you for any outstanding debt on the card and, for better or worse, the resulting impact on their credit history.

Banks That Accept Co-signers

Among the major credit card providers, only a few, such as Bank of America and U.S. Bank, allow for joint or co-signed accounts, while most others, such as American Express, Capital One, Chase, Citi, and Discover, do not.

Should You Ask Someone to Co-sign Your Credit Card?

According to most credit experts, however, it’s not really a question of can you get a co-signed credit card, but rather, should you?

The answer, according to those same experts, is virtually unanimous.

Experts Agree: Avoid Co-signed Credit Cards

“Few people realize what they’re asking when they ask someone to co-sign,” says Ben Woolsey, president and general manager of CreditCardForum. “They think the bank just needs someone as a credit reference. It’s way beyond that, and something that’s never really a good idea.”

Among the many drawbacks to pursuing a co-signed or joint account is the significant risk you’re asking that co-signer to accept, according to Michelle Black, a credit expert with HOPE4USA, an organization that specializes in helping consumers and businesses repair and access credit. Ultimately, the co-signer has nothing to gain and everything to lose. If you fall behind on payments, they must either pick up the slack or see their own credit dragged down by your failure to stay current.

“Co-signing is like playing Russian roulette with your credit scores,” says Black. “It’s extremely dangerous and typically ends badly.”

The fact that all of the risk associated with a co-signed credit card generally falls on the shoulder of the co-signer often creates challenges that go beyond the financial realm, according to Woolsey.

“It’s something people should approach carefully with respect to the ethical position you’re putting someone in,” Woolsey says. “Aside from the financial risk, there’s also the dynamic of potentially hurting the personal relationship, and that’s something people don’t really think about.”

Fortunately, there are many alternatives to co-signed credit cards, most of which are equally effective at providing access to credit and building your overall credit profile, without the financial and moral hazards.

Alternatives to Getting a Co-signed Credit Card

Become an authorized user on someone else’s account

One of the best alternatives to a co-signed credit card is to have someone add you as an authorized user to an already existing account, says Woolsey.

“It gives you all the benefits of getting a card in your own name, but it gives the primary account holder the control they don’t have as a co-signer, because they can revoke that privilege any time they want,” he says.

Whereas only some of the aforementioned credit card companies allow for co-signed credit cards, all allow for the addition of authorized users to an account.

Get a secured credit card

If you’re strictly looking to build or improve your credit, the secured credit card is another alternative. With a secured credit card, you put down a cash deposit that in turn becomes the line of credit for your account. If you put down a $1,000 deposit, you have $1,000 against which to spend and build credit. As you make “payments” on your secured card over a set period of time (usually 6 to 12 months), the lender will report your good behavior to credit bureaus. Some lenders may even upgrade you to a traditional credit card once you’ve proven you can make on-time payments.

Most major credit card companies offer secured credit cards, as do most credit unions.

“Secured cards can be a wonderful credit-building tool when managed responsibly,” says Black.

Take out a personal loan

If you’re looking to build your credit profile while also gaining access to cash, a personal loan is another option to consider, says Tim Hong, SVP of Products at MoneyLion.

“When you agree to a personal loan, you get your funds upfront and have a steady, predictable payment schedule,” Hong says. “You know exactly how much it will cost over time and when you’ll be done. That’s a dramatically different and more predictable experience than a credit card.”

Apply for retail credit cards

Finally, borrowers needing to build their credit profile can always fall back on the old-fashioned store credit card. Though not everyone is a proponent of store credit cards, most such cards, especially those from retailers, tend to have a lower barrier to entry than standard credit cards, says Ryan Frailich, a financial coach and planner based in New Orleans, La.

“Of course, since they’re taking on more risk by approving cards for those without a great track record, they also have the highest interest rates,” says Frailich. “If you go this route, you have to be absolutely certain you can pay off the full balance monthly.”

The Bottom Line

Whether you find a co-signer for your credit card or pursue one of the many alternatives, the experts agree your primary focus should be on building your credit to the point where banks will approve you on your own.

“What it boils down to is that co-signing is really just one option amongst many,” says Hong. “In the big picture, it’s about showing that reliable payment history and improving your credit score so you avoid having the need for the co-signed card to begin with.”

 

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6 Reasons to Think Twice About Co-Signing a Loan

co-signing-a-loan

If your credit and finances are in good shape and you have friends or relatives who are not in such a good credit position, you may have been approached to co-sign for a loan or credit card.

While your friend or relative may deserve the help, it’s not always wise to lend a hand to a sagging financial situation. Here are six reasons why you should think twice before you sign on the dotted line for someone.

1. Risk-to-Reward Ratio Doesn’t Favor You

If you co-sign a loan, the liability lies squarely on your shoulders should your friend or relative not make the payments. They may still be enjoying the home or car they got with the loan while you are left holding the bag on the responsibility of paying it off. And, if you don’t…

2. A Lender May Sue You if Payments Are Not Made

“When a cosigned loan goes into default, the creditor can collect against all who are named on the account since they have an equal share of the responsibility to repay the entire balance,” according to Bruce McClary, vice president of communications for the National Foundation for Credit Counseling. “A creditor can make their own decision to pursue the primary borrower or collect from the cosigner. It is common for a lender to make first attempts to contact from the primary before turning attention to the cosigner.”

3. If a Loan Payment Isn’t Made, Your Credit Is Impacted

The co-signed loan will appear on your credit reports, including the payment history — good or bad — for the loan. While the damage late payments can do is mitigated over time, generally, your credit report can be severely impacted for years. You can see how your payment habits are affecting your credit by viewing a snapshot of your credit report, updated every 14 days, on Credit.com.

4. Your Relationship May Suffer

As the old saying goes, “money and friendships don’t mix.” Placing your credit report and therefore credit scores in the hands of another individual can place a strain on a relationship. You may begin to notice other money behaviors that you previously thought were quirky or endearing that now seem alarming. Your feelings about your loved one may change in a negative way.

“It is not uncommon for relationships to end when cosigned loans slip into default, leaving much more than a financial mess,” McClary said. “This can be prevented if people either avoid cosigning altogether or proceed with a plan that accommodates for keeping the lines of communication open during hard times.”

5. You Could Face Tax Consequences

When autos are repossessed, there can sometimes be what is known as a deficiency balance. This is the result of when the lender has repossessed the vehicle, takes it to auction and is not able to recoup the amount still owed by the borrower.  Some lenders will forgive or write off a deficiency balance if it’s obvious the borrower has no assets, but if you’re co-signing for someone, chances are there are enough assets between you and the person you’ve co-signed for that the lender is not going to be as lenient. In that case, the deficiency balance could be turned over to a collection agency that may be willing to cut a deal to accept less money than is owed and will mark the debt as paid in full.

In the case of credit card debt, once a debt goes 90 days delinquent, a bank is usually willing to talk debt settlement.

In cases where the amount forgiven during debt settlement (or the difference between what is owed and what the lender gets for a car at auction) is $600 or more, a lender must issue a Form 1099-C or 1099-A to the borrower (and the co-signer) and the difference must be reported as income on that year’s tax returns. That’s because the difference between what is paid on the debt and what is owed is considered a net income gain by the IRS, and taxes need to be paid on this gain. If your tax bracket is 28% and the amount forgiven is $2,000, you could wind up owing Uncle Sam an additional $560 come April 15.

6. You May Be Turned Down for Other Loans

Even if your friend or relative makes all the payments on time, your borrowing ability will be affected.

“Provided that the creditor reports account activity to the credit bureaus, cosigning a loan will likely mean that the account will show up on the cosigner’s credit report,” McClary said. “This means that it will impact their debt ratio, which influences a lender’s decision about whether they can afford to take on more debt.”

Image: BartekSzewczyk

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Is There a Difference Between a Co-Signer & a Co-Applicant?

The terms “co-signer” and “co-applicant” may sound like they’re the same, but there are actually some key differences between the two that are important to understand if you’re thinking about financing a loan alongside friends or family members.

What’s the Difference?

A co-applicant, also sometimes referred to as a co-borrower “is a full-fledged partner in the account or loan transaction,” Thomas Nitzsche, media relations manager for ClearPoint Credit Counseling Solutions, said in an email. Each person has all the same rights and responsibilities pertaining to the loan and, when it comes to applying for the financing, both parties’ financials, including income, are generally used to calculate how much credit should be extended, he said.

Co-applicants are typically common when it comes time to buy a home.

“For mortgages, this divides the responsibility of repayment equally between the two property owners,” Bruce McClary, vice president of public relations and external affairs at the National Foundation for Credit Counseling, said in an email.

But, no matter what type of financing is involved, both parties are on the hook for any missteps.

“If defaulted, both parties are equally fully responsible even if it was only one of them who ran up the charges (we usually see this with credit card accounts when clients divorce),” Nitzsche said.

Co-signers, on the other hand, are generally added to an account in order to help someone with no credit or bad credit get financing.

“The healthy credit record of the co-signer can help the other person get past credit approval thresholds and qualify for more affordable rates,” McClary said. But, despite that role, a co-signer generally isn’t granted the same usage rights as the primary borrower. (For instance, a co-signer on a mortgage may not have property rights to the home.)

Still, “if the primary applicant fails to repay the account according to the terms of agreement, the lender can [pursue] the co-signer for the remaining balance,” McClary said.

It’s also possible to be a guarantor, someone who “guarantees” a loan for a friend or family member.

“A ‘guarantor’ … is similar to a co-signer except that the guarantor doesn’t become liable until the bank has exhausted all other means of collection from the primary borrower,” Nitzsche said. “With a cosigner, the bank can come after both parties right away for collection.”

Considering a Co?

Remember, in all these instances, you could ultimately be on the hook for payments and charges. Plus, any unpaid bills, defaults, collections accounts, or, if the debt is attached to a mortgage, short sale or foreclosure, will likely appear on your credit report and damage your credit score. That’s why you should always consider all your options very carefully before signing alongside someone on those dotted lines.

And, no matter what route you go, it’s important to keep an eye on your credit so you know how any co-signed or joint accounts may be affecting your credit. (You can view two of your credit scores for free each month on Credit.com.)

If a co-signed or joint account has tanked your credit, you may be able to improve your score by disputing errors on your credit report, paying down high credit card balances and limiting new credit inquiries until your score rebounds.

More on Credit Reports & Credit Scores:

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