Published: June 6, 2016 10:07 a.m. ET
‘My kid isn’t paying the loan I cosigned?’
It’s hard to say no to your children, but in the case of cosigning a loan for them, it’s sometimes prudent.
Nearly half (45%) of the people who have cosigned a loan — a cosigner agrees to pay the loan should the main borrower default on it — are parents who have done it on behalf of their children or stepchildren, according to a survey of roughly 2,000 adults released Monday by CreditCards.com. (This is by far the most common cosigning scenario, with cosigning for a friend a distant second.)
Parents often do this to help their adult children — who may have a short or even shoddy credit history — buy something like a car (this is the most common), qualify for a mortgage, or get a credit card or private student loan, that the child might not have been able to get on his own.
“Parents do it because they want to give their kid a leg up,” says Matt Schulz, senior industry analyst at CreditCards.com, a credit card comparison site. “They’re hoping everything is going to go great, but it doesn’t always.” Here are three major risks of cosigning a loan for your kids.
You’ll foot the bill yourself
Nearly four in 10 people who cosigned a loan ended up having to pay some or all of the bill because the primary borrower didn’t pay it, the survey revealed. That’s because “when you cosign a loan, you are 100% responsible for that loan,” says David Hryck, a New York City tax lawyer and partner at Reed Smith. “Should there be a failure to pay the loan, the lender can now come after you for the entire amount.”
For parents of adult children, having an additional monthly payment can derail their ability to save enough for retirement. Already, people ages 55 to 64 (many of whom have adult children who might need a cosigner on a loan) have just over $100,000 on average in retirement savings, according to a report from the Government Accountability Office; that’s too little, at least according to Fidelity, which recommends that by age 50, Americans should have six times their salary saved for retirement.
You’ll damage your credit
More than one in four cosigners (28%) experienced a drop in their credit score because the main borrower paid late or not at all. That’s thanks to the fact that if the person paid their loan late, even if you didn’t know about the late payment as a cosigner, that late payment appears on your credit report. (Furthermore, even if they don’t pay late but do max out the card, that can hurt your credit utilization, which is part of your credit score.)
“Late or missed payments will be ugly stains on your credit report, says financial writer Valerie Rind, the author of “Gold Diggers and Deadbeat Dads: True Stories of Friends, Family, and Financial Ruin.” Furthermore, those stains “can cost you thousands of dollars because of higher interest rates so you’ll pay more on mortgages, car loans, credit cards, etc.,” says Schulz. “It’s a big deal.”
You’ll harm your relationship with your child
Fully 26% of cosigners say their relationship was damaged because of cosigning. “You would expect that the parent goes in with the best of intentions so it would be a pretty big breach of trust if the child did not handle business properly on something mom and dad cosigned for,” says Schulz. “It’s clear that cosigning is causing some awkward conversations around the dinner table.”
That said, there are some compelling reasons to cosign a loan for a child. It can help the child get a better interest rate on a loan (assuming your credit is great), saving him potentially thousands of dollars down the road, and to buy something he needs that he couldn’t otherwise get.
Still, parents have to be careful. First, “if you are going to cosign a loan for someone, you need to be sure that you can afford to take over the loan payments if the other party stops paying,” says attorney Sonya Smith-Valentine, the president of financial wellness firm Financially Fierce.
Next, you must have an “in-depth conversation with the other party” before you cosign, says Hryck. Talk about your child’s responsibilities when it comes to the loan, what will happen if issues arise, and more.
You also want as much information as you can get both before you cosign (ask for their credit report and talk about their past payment history and other loans and financial issues) and after. “My biggest piece of advice for someone considering cosigning is to live by the motto ‘trust but verify,’” says Schulz. In other words, make sure you have a lot of access to the account such as the balance information, monthly statements and notifications on things like late payments, so you can deal with potential problems before they become actual problems.