Dear Penny: Can I avoid the risk of default if I co-sign my daughter’s mortgage? | Company
We have a 47 year old daughter whose divorce has just been settled. She is a teacher, but she does not work full time. She asks her parents to co-sign the purchase of a house.
We are retired and have a paying house. What financial tool could we use to protect ourselves from the possibility of default?
You can’t be a co-signer without putting your finances at risk. From a bank’s perspective, this would run counter to co-signing.
When a person does not qualify for a loan or credit on their own, the lender can sometimes approve their application if they find a co-signer. If you are considered an acceptable co-signer, it means you have a strong credit history. The lender has basically determined that you are not ready to jeopardize this immaculate credit, so you would be ready to step in and make payments before leaving this loan in default.
If you co-sign a mortgage for your daughter and she defaults, the consequences would be the same as if you were the original borrower. The default would remain on your credit report for seven years. You would have difficulty getting credit for yourself, especially in the first two years after default. Even if your daughter makes payments on time, you are still increasing your debt ratio since you are legally responsible for the mortgage.
It’s admirable that you want to help your daughter through a difficult time. But unless you’re able to make mortgage payments for her, I urge you not to co-sign. My advice to co-signers is to hope for the best but assume the worst, i.e. you will be the one making the payments.
Remember: banks make money by lending. When they are unwilling to approve a loan without a co-signer, they pass on potential profits because the risk is too great.
Ask yourself if there are other ways to help your daughter financially without incurring such huge debt. Could you allow her to move in with you to replenish her savings? If she has black marks on her credit report, the damage will begin to heal in about two years. Plus, if she can eventually go back to full-time work, she’ll probably have an easier time getting a mortgage.
Or could you help pay the cost of renting an apartment? If she needed a co-signer to rent, I’d be less opposed to you putting your name on a lease than a mortgage. Your liability would likely be capped at one year’s rent versus 15 to 30 years of mortgage payments.
You can also help your daughter by giving her money for a down payment if you and your spouse have decent savings. A substantial down payment reduces the risk for the lender, making it easier to approve a borrower with precarious finances.
If you’re determined to co-sign for your daughter, having open lines of communication is key. Set a strict limit on the loan amount you are willing to co-sign. Make sure your daughter is aware that you are putting your own credit and assets at risk by taking responsibility for her home loan.
Most importantly, be clear about what your daughter should do if she is unable to make payments. If she knows she can’t afford a payment, she should let you know as soon as possible. You don’t want to find that she’s struggling after already missing payments.
For added security, you might require that you have access to your daughter’s account with her lender. This way you can check at any time that she has made the payments as agreed. You can also have the lender send you alerts each time a payment is made for easy tracking.
Also find out what the lender’s policy is to release you as a co-signer. Sometimes it is possible to remove your name from a loan after a number of timely payments, particularly if the original borrower’s income increases and their credit rating improves. But lenders are often extremely reluctant to do so because it increases their risk. To remove your name from the mortgage, your daughter may need to refinance in her name alone.
If you’re not ready to take the risk of co-signing, be honest with your daughter. It’s not about your love for her or your willingness to help her. Nor is it a moral judgment for the financial situation in which she finds herself. Once you retire, you need to be extremely careful about taking on more debt, as you usually have a fixed income.
Your daughter is probably trying to get out of a difficult chapter in her life. Of course, you want to give her love and support. But unless you’re okay with making his mortgage payments, you simply can’t afford to show your support by co-signing.
Robin Hartill is a Certified Financial Planner and Senior Writer at The Penny Hoarder. Send your tricky money questions to [email protected].
This was originally posted on The Penny Hoardera personal finance website that empowers millions of readers across the country to make smart decisions with their money with practical, inspirational advice and resources on how to earn, save and manage the money.