Should You Co-Sign on Your Child’s Loans?

on Topics: Loans

Should You Co-Sign on Your Child’s Loans?

As a parent, you work hard to raise a child who becomes a contributing member of society, who is successful, and who is happy. You want to support your child in reaching their goals and help them to build a happy life however you can. For some, the path leads through college and graduate school. For others, an entrepreneurial spirit guides them into starting their own business. Some may choose to travel and still; others may set down roots and aim to build their own home right out of the gate. Whether the next step in higher education, a business venture, or a home, there is a cost associated with leaving mom and dad. Often hefty, the cost of these next chapters often exceeds what most Americans can afford, but for financing. You want to help your child transition to this next phase of life and set them up for success, but at what cost? Does that mean you should co-sign on their loans?  

Why does your child need a co-signor?

Creditors want to loan money to people who will pay it back. To evaluate an applicant’s likeliness of problem-free repayment, creditors look to the applicant’s credit history. Past behavior is the greatest predictor of future performance. Unfortunately, many young adults do not have credit history and therefore, a creditor is unlikely to loan your child the forty-thousand dollars they need for college tuition or the hundreds of thousands of dollars needed for their business venture. 

While there is nothing wrong with supporting your child throughout high school and beyond, it will be difficult for a young adult without any credit history to obtain new credit to finance large expenses. Therefore, many young adults need a co-signor with credit history to get loan approval, regardless of the amount sought. This is where you come in. As the young adult’s parent, it is likely that you do have credit history which the creditor can look to in evaluating your ability and likeliness to repay the borrowed amount in the event your child does not. While your young adult may not have assets, it is likely that you, with an established credit history, do have assets that could be held in satisfaction of the debt should your child, or you, default on the loan. 

By co-signing for your child, they may get the loan they may not otherwise be approved for which could be the very reason why you decide not to co-sign. Creditors have systems in place for evaluating how likely a person is to repay a loan – and if the creditor says your child is too much of a risk to approve for a loan, it could be worth exploring whether your child is truly ready and capable to manage this debt or if there is another way you can help your child build credit and raise the funds they need without putting your credit at risk.

Ultimately, everyone starts somewhere. You must have credit to get more credit and without credit, it is difficult to get started building it. Co-signing on a loan for your child may provide the step-up your child needs to begin building credit, but this move is not without risk to you. 

What are the consequences of co-signing for your child?

Why will the creditor approve your child’s loan application if you co-sign on it? It’s simple: because your child is not the only one responsible for repaying the loan. If your child is unable to make the required payments or otherwise defaults on the loan, you become responsible for paying the balance. Furthermore, if neither of you repays the loan, the creditor can take civil action against you and your assets in satisfaction with the debt. This is another reason the creditor may deny your child’s application – lack of assets to recover the debt in the event of a default. If you co-sign, you provide the creditor with the assurance that they will get their money back, one way or another. 

In addition to the potential liability associated with co-signing on a loan, the account will impact your credit report just as if you took out the loan yourself. If things go well, the impact will be insignificant – just another account in good standing though it will impact your debt-to-income ratio which is a factor in your credit score. However, if payments are missed, if the account goes into default or is turned over to collections, this will drag down your credit score and will be reflected in your credit history which can impact your ability to obtain new credit in the future. 

Furthermore, loaning money to the family always comes with a risk to the relationship. When you put your credit and finances on the line for a loved one, emotions will inevitably be involved if the family does not fulfill their part of the financial obligation and puts you in a bad spot. 

How can I help my child build credit without co-signing on a loan?

Instead of co-signing on a loan, you can loan your child the money needed to open a secured credit card. This card operates like a debit card in that the credit limit on the card is determined by the amount of money deposited when the account is opened. Therefore, it eliminates the risk of over-extending finances because it will not allow the individual to spend more than the cash that is present.

Another option to help your child is to loan money directly and have your child repay you over time. Though this does not help your child build credit officially, it will provide your child with the needed funds now and help them learn how to manage debt responsibly.

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