As a parent, it’s normal to want to do everything in your power to help your children succeed. However, when it comes to financial matters – such as co-signing on a mortgage – it’s usually best to take a step back and examine the situation carefully before moving forward. Otherwise, you may put yourself in a bind or damage the relationship. If you’re thinking you should co-sign on a home with one of your children. Here’s what you need to consider.
What You Need to Consider Before You Co-Sign on a Home with One of Your Children
Your Financial Situation
When you co-sign on a home loan. Even if the intention is that your child will handle all of the associated costs, you’re committing to repaying that mortgage. Even when your child takes care of everything as promised, a large loan shows on your credit report. It’ll impact how lenders view your debt-to-income ratio and can affect your credit score in different ways over time.
In some cases, a new mortgage could hurt your chances of getting new financing if you need it or might lead to higher interest rates. Mainly, it’s because lenders have to assume you may be making the payments, which could make you seem overextended.
There’s also the issue of your child missing a payment or defaulting. Since your name is on the loan, their poor financial activity impacts your credit report. Additionally, you’re legally obligated to repay the loan, too. If an adverse situation arises, you may find yourself stuck in a complex legal and financial matter.
Ideally, you need to ensure that you won’t have a need for any new financing personally or that your creditworthiness remains intact even if there’s a new mortgage on your report. Additionally, you need to have the financial means to take over payments immediately if your child is at risk of missing a payment or defaulting. If those don’t apply, then co-signing is dangerous.
Why Your Child Need a Co-Signer
One of the first points you need to examine is why a co-signer is necessary for your child’s loan. Essentially, you want to know why the bank doesn’t feel they qualify – either at all or for a competitive rate – without someone else being on the mortgage.
In some cases, requiring a co-signer isn’t inherently indicative of a significant problem. For example, many younger adults only have a limited credit history. As a result, they may not have a strong credit score even though they maintain good financial habits. It’s simply because they haven’t engaged with enough financial products to show lenders their creditworthiness.
However, if high debt-to-income ratios, a poor repayment history, or something similar is causing the lender to require a co-signer, that’s potentially a different story. When that occurs, there are red flags that your child may not be a responsible borrower, which makes co-signing particularly risky.
How Co-Signing May Impact the Relationship
Co-signing on a mortgage for a child can impact your relationship. There’s a chance you may judge their behavior moving forward, particularly when it comes to how they manage their money or treat the property. A choice that you view as poor could cause hard feelings, especially if it feels as if they’re putting your financial wellness at risk.
However, even if you aren’t actually doing it, there’s a chance your child may assume that you are judging their choices. This could cause them to view the relationship differently, potentially in a harmful way, regardless of how you’re responding to the situation.
In the worst-case scenario where your child misses a payment or defaults, you’re now in a challenging situation. At a minimum, it’s going to lead to a difficult conversation regarding you having to take over the payments. This can create hard feelings, even if paying the debt is within your capability.
On the other side of the spectrum, if you can’t manage the payments either, the circumstances are far harder to navigate. Your credit is hurt because of their actions, and you may end up in collections, with a foreclosure on your record, or other serious adverse actions on your report because they failed to pay. You may view this as a severe breach of trust, and the harm to the relationship could be severe, if not irreparable.
Alternatives to Co-Signing on a Home with a Child
In some cases, there are alternatives to co-signing on a mortgage that could still help your child succeed financially. What option is best may depend on the exact reason they’re considering a co-signer.
If they need a co-signer because they lack credit history, finding a safer way to help them build there’s up might be a better choice. For instance, you could add them as an authorized user to one of your credit cards, allowing them to benefit from your good financial habits. Co-signing on a smaller personal loan that’s easier to take over if something goes awry could also work.
Another option is to provide your child with down payment assistance. That can lower the amount they have to borrow, potentially skewing things in their favor. Each parent can give a child a gift of up to $16,000 (as of 2022) per year without the child incurring any tax-related responsibilities. That can lead to a potential tax-free total of $32,000.
If you’d like to give a larger down payment, then the lifetime gift exclusion may come into play. Since that’s potentially complex, you may need to consult with an accountant or similar financial professional to determine the possible consequences of doing so.
Finally, if you’re financially able, you could purchase the home on your own. Then, rent it out to your child for the monthly mortgage payment amount. If their financial situation later improves and they can purchase the house from you, then they can get a loan, and you can transfer ownership that way. If not, then you potentially have an investment property that you can rent to others or sell.
Should You Ever Co-Sign on a Home with One of Your Children?
Ultimately, co-signing on a home with one of your children is risky. At a minimum, it impacts your credit, often limiting your access to new financing if you would need it.
However, it also puts you on the hook for a large debt. If your child may miss payments or default, repaying the loan is your responsibility. If you can’t do it, then you’ll also face the consequences of going to collections or ending up in foreclosure. Plus, co-signing on a mortgage can put a strain on the relationship.
Now, this doesn’t necessarily mean that co-signing is never a good idea. If you’re able to handle the financial part of the equation without an issue and the relationship is strong, with solid communication, then it may be alright. Just keep in mind that using an alternative may be a better choice, allowing you to offer assistance without taking on unnecessary risk.
Do you think it’s ever a good idea to Co-sign on a home with one of your children? Did you co-sign on a home loan and want to tell others about your experience? Share your thoughts in the comments below.
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Tamila McDonald has worked as a Financial Advisor for the military for past 13 years. She has taught Personal Financial classes on every subject from credit, to life insurance, as well as all other aspects of financial management. Mrs. McDonald is an AFCPE Accredited Financial Counselor and has helped her clients to meet their short-term and long-term financial goals.