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Innovations and Payment Systems

To co-sign or not to co-sign

Summary

A mother wants to help her daughter buy a house, but due to the daughter’s bad credit, will have to co-sign the loan. ‘To Her Credit’ columnist Sally Herigstad weighs the benefits and the risks of co-signing on someone else’s loan.

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Dear To Her Credit,

My 40-year-old daughter wants to buy a house, but her credit is lousy. Fortunately, she has a decent job. She’s asked me to co-sign a loan with her. I’ve read the experts’ advice not to co-sign on a loan, but this looks like it’s the only way my daughter can get her own place (and move out of my house with her three cats). I have a good credit score and my finances are stable. How could co-signing with my daughter affect my credit? Should I help her?
Gwen

Dear Gwen,

Co-signing on a loan with your daughter can adversely affect your credit score, even if your daughter never misses a payment. That’s because creditors assume you are liable for the whole debt — which in fact you are. Say a few years after you co-sign on the loan, you apply for credit. If it looks like you’d be strapped making your daughter’s mortgage payments, you’ll be considered a higher risk. You could be offered a lower credit limit or higher interest rates, or you could even be turned down.

An bigger question is: Five years from now if your daughter defaults and you end up making the payments, will you still be glad you co-signed? Will you be able to make the payments? If you can answer “yes” to both questions, go ahead and co-sign. Your daughter gets a chance at homeownership, she will appreciate your help, and you’ll get the cat hair off your couch.

Don’t co-sign without knowing what you’re getting into, though. Some people view co-signing as a mere formality to help someone get a loan. It’s not. As I learned the hard way, co-signing on a loan means you’re guaranteeing the lender gets paid. If you co-sign and the other person doesn’t make the payments, you do. The lender doesn’t even have to try very hard to get payments from the co-signed borrower. It’s probably easier to get payments from you, the person with good credit, so that’s what they’ll do. In the meantime, your daughter still gets to live in the house. Nobody plans on things turning out this way, but sometimes they do — and when they do, it’s never good for family relationships. According to the Federal Trade Commission, as many as three out of four co-signers end up making the payments for their friends or relatives.

Instead of co-signing, consider other ways to help your daughter. You could buy a house and rent it to her, for example. If she doesn’t pay the rent, at least you own the home. Some people buy duplexes or tri-plexes and have an adult child manage the property in exchange for reduced rent. Or, you could give your daughter enough money for a down payment. She may qualify for a mortgage herself, even with a sketchy credit history, if you give her a sizeable amount to put down.

If you still want to co-sign on the loan, you can take steps to reduce the chances of things going awry:

•  Make sure the mortgage is a reasonable amount for her to handle. She’ll have a better chance of keeping up with it if she has some leeway in her budget.
•  Also, if she has “lousy” credit, that may be a sign that she has trouble organizing and prioritizing her bills. Setting up an automatic mortgage payment for every month just after her paycheck is deposited may help her make sure at least that bill gets paid.
•  Have the lender send copies of monthly statements directly to you as well as to your daughter.
•  Tell the lender to contact you immediately if a payment is late. Late payments affect your credit score, even if you don’t know about them, and late payment fees and interest increase the amount for which you are liable.

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