Parents like to help their kids -- even when their kids are adults. These days, with mortgage lending becoming much tighter, fewer young people are eligible for mortgages with terms they can afford. And more parents may be tempted to step in and cosign. But there are big risks and both kids and parents should weigh them before entering into that kind of financial agreement.
Cosigning is shouldering a debt along with a child. A parent will be just as responsible for the debt as the child is. And though the child is the primary borrower, the debt will show up on the parents' credit record.
Cosigning cannot help if the child's credit is bad. With the financial debacles of recent decades, banks are learning that regulators will not overlook ill-advised loans to risky customers, no matter how creditworthy the co-signer. Cosigning can help when a child's credit is marginal to get a larger loan or more favourable terms. Cosigning also can help when the child has not established a credit history. Cosigning is not generally the difference between a loan and no loan, but is, instead, the difference between buying a low-value house or a more valuable one in a choice neighbourhood with better mortgage terms.
Parents need to understand that if the child cannot make payments, they will have to. They need to realistically assess how making that monthly mortgage payment will affect them financially. Parents also need to recognise that, even as co-signers, they will have the loan on their credit record. If the parents need to borrow money for something else, they may be declined because lenders see them as financially overextended.
While the Federal Housing Authority permits cosigning only on FHA loans for people who are relatives, some lenders might not permit cosigning for anyone who is not planning to live in the house. Parents might not be eligible to cosign even with a good credit record. Lenders also look at income and debt-to-income ratio. Check the lenders' policies before applying.
The Bottom Line
The Federal Trade Commission reports that three out of four co-signers wind up paying. Before cosigning, consider how a loan default will affect not only your finances but also your relationship with your child.