As your child heads off to college or starts life as an independent young adult, he or she will likely face new financial responsibilities. To manage these new responsibilities, such as a car purchase, rent or college payments, your child may decide to take out a loan or another form of credit. Given their lack of credit history, it can be difficult for young adults to obtain a loan without a parent or another adult cosigning the loan.
Deciding to cosign a loan with your child is a noble gesture, but it’s not a position to be taken lightly. Before you sign on the dotted line, consider your own financial situation.
Cosign with your eyes wide open
Even though you may not consider it “your loan” if you cosign, lenders will identify you as one of the borrowers. That means you may be at risk if different circumstances arise, such as the following:
• Any of the balance remains unpaid by the borrower, the cosigner is required to repay it.
• The borrower defaults or even misses one or two payments, it can detract from the cosigner’s credit record.
• Even without a default, other lenders may look on this loan as an additional liability the cosigner will need to pay, which could also affect a cosigner’s credit record.
• In some states, the creditor has the right to collect payment from the cosigner without first trying to collect from the borrower.
• The cosigner should die, it may trigger “auto default” provisions in the loan contract. This requires the borrower to immediately pay the debt in full in the event of the cosigner’s death. Regulators discourage this practice, but it still exists in some loan agreements.
Steps to protect your position
Alternatives to a loan that requires a co-signature should be explored. For example, students should consider taking full advantage of federal student loans or aid. Parents may want to lend children money directly, if their financial situation allows them to do so. Whether or not you’ve determined that you are willing to cosign a loan, take steps to help protect yourself. These include but are not limited to:
• Reading the fine print and fully understanding the terms of the loan and the expectations of the lender.
• Avoiding pledging property, such as a car, to secure the loans as this creates additional risk.
• Arranging to receive duplicate copies of all paperwork such as statements so you can stay on top of the borrower’s record of repayment.
• Having complete online access to the account just as the borrower does.
When you are considering co-signing for a loan, treat the situation with the same diligence that you would if you were borrowing money yourself. Do what you can to help make sure your potential act of generosity doesn’t impair your ability to obtain credit in the future.
William “Drew” Watson CFP® is a Financial Advisor and Private Wealth Advisor with Ameriprise Financial Services, Inc. in Owensboro, KY. He specializes in fee-based financial planning and asset management strategies and has been in practice for more than 20 years. To contact us by phone, please call 270-684-8424 or by mail at 111 West 3rd St., Owensboro, KY 42303. You may also visit our website at www.williamawatson.com.