If you have a good credit history, you may consider co-signing a loan with your child to cover their tuition.
However, what appears to be a noble act might have unintended consequences.
Let’s go through the risks and benefits of co-signing a loan so you can make an informed decision when someone asks you to co-sign a loan with them.
But first, let’s start by defining what is a co-signer on loan exactly.
Co-signer is a person who applies for a loan alongside another person and legally commits to pay it off if the original borrower is unable to make payments. A co-signer might be a trustworthy friend, family member, or someone close to you as long as they have a good credit score and a steady income.
Co-signers are commonly used when a borrower is unable to obtain a loan due to their credit score, low income, or current debt.
This is the most significant risk as co-signing a loan entails more than simply donating your good credit to your child.
It is a commitment to pay their financial obligations, including any late penalties or collection expenses, if they are unable to do so.
Before you sign a co-signing agreement, make sure you can afford the loan installments if the original borrower is unable to.
After you co-sign a loan, the loan itself, as well as the payment history will appear on both your and the borrower’s credit reports.
The essential thing to remember is that any missed payments by the borrower will harm your credit score.
Because payment history has the most significant impact on credit ratings, making a misstep here can ruin your credit.
Co-signing a loan for a loved one carries the long-term risk of being rejected for credit when you need it.
When calculating your total debt levels, a potential creditor will consider the co-signed loan and may conclude that providing you another credit is too risky.
According to the Federal Trade Commission, in case the lender doesn’t receive payments, it can try to recover money from you, the co-signer, before it goes after the actual borrower in some states.
The borrower would have missed multiple payments to reach that point, and the loan would have already begun to impact your credit. When a loan is 90 to 180 days past due, lenders are more inclined to seek legal action.
If the worst happens and you’re sued for not paying the loan, you’ll be accountable for all charges, including attorney’s fees.
Your child may start making payments on time toward their loan or credit card. However, their financial and personal circumstances can change.
When children have difficulty making payments on a co-signed credit card or auto loan, they may hide the problem from their parents until the situation worsens, destroying trust in their relationship.
Cosigning a loan is clearly only beneficial to the person for whom you agree to cosign.
For example, it may be an excellent way to help your child develop credit. Lenders need to make sure that the young adult applying for a loan or credit card is reliable. But young adults who are just starting out their career and have no credit history may find it difficult to secure a loan with a reasonable interest rate.
Cosigning for your child helps them to begin developing credit history while also guaranteeing the lender that they will be paid back.
Now that you understand the consequences of co-signing a loan, you can decide whether to agree when your loved one asks you to co-sign.
As you can see, there are more risks to co-signing a loan than benefits. However, co-signing a loan for your child may be more beneficial for both of you than risky – depending on your relationship and financial situation.
Many private student loans don’t require a co-signer. Make sure to shop around to get the best rates and conditions on a student loan.
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