We asked John McCafferty, director of financial planning at Edelman Financial Engines in Alexandria, Virginia, and Chaim Geller, financial advisor and founder of Help Me Build Credit in Brooklyn, for parenting advice. Both responded via email and their comments have been edited.
A major concern with co-signing is that as a co-signer, the parent has no rights to the property but assumes responsibility for the entire debt, McCafferty wrote.
Q: When should parents consider co-signing a mortgage for their adult children?
McCafferty: Parents get involved when an adult child is financially unable to qualify for a mortgage on their own. There are pros and cons to being a co-signer. I would only recommend a parent to go ahead if it is very clear that their own financial health – such as their retirement savings – will not be jeopardized.
Geller: Co-signing is one of the greatest favors a person can do for their child. But co-signing isn’t for everyone. To make sure you don’t have regrets, you need to understand how serious it is to sign together. It has to make financial sense and you have to have the right level of trust in your child. If you don’t, signing together can be a devastating mistake that can have serious consequences. It can ruin you financially, ruin your credit, and worst of all – cause a rift in your relationship.
Q: Are there some red flags if co-signing a mortgage is a bad idea?
McCafferty: Yes, the fact that a co-signature is required is a red flag and should at least prompt the parties involved to ask themselves, “Why is a co-signature required?” While the answer is obvious, it is important to go through the review process . It can be expected that mom and dad will have to help, especially if they have taken care of most other financial obligations up to this point.
But there are many reasons to believe that this important responsibility would not be in their best interest, and they should discuss all the variables. For example, what is the borrower’s career path like? Is he or she married? If so, what is your spouse’s professional background? Do you have children? The list of questions can be long and there are a number of risks. Meanwhile, the child uses the parents’ financial situation to buy something they may not be able to afford. For the parent company, this results in a higher debt-to-income (DTI) ratio, which could negatively impact its creditworthiness and future borrowing potential. Relationships could also be affected if there are problems making payments.
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Through this lens, I encourage common sense and don’t let the family relationship cloud thinking. The key question I ask clients is: would you agree to this type of arrangement if your child were not involved?
Geller: Young adults often have unrealistic dreams, and your children may dream of buying a house they cannot afford. Before you co-sign for your kids, sit down with them and discuss their finances. what is her income What are your monthly expenses? How much do they spend on groceries, restaurants, etc.? Do you have monthly car payments? This should help you see if you feel confident the mortgage is affordable for you. Leave some financial wiggle room for unexpected expenses. If you feel that they are overexerting themselves and concerned that they cannot afford the mortgage payments, then politely explain that you are recommending that they find a more affordable home, or they can exclude you from co-signing.
Q: How does co-signing work? Do parents have to pay anything when they graduate?
McCafferty: A co-signer helps a borrower qualify for a mortgage by agreeing to repay the loan if the borrower stops making payments. As a co-signer, you have no ownership interest in the home and your name will not appear on the title deed. An ideal co-signer will have a high income, excellent credit history, and a healthy debt-to-income ratio.
Co-signers complete a home loan application as part of the process.
After the lender’s terms have been met, the co-signer must agree to all the terms of the loan by signing the final loan agreement documents. As an official loan agreement, the note contains all the important terms of the loan.
If the borrower does not have sufficient funds at closing, the co-signer may be required to cover all down payments, closing costs, and associated additional fees.
Q: Is helping with the deposit a better option than co-signing? Why or why not?
McCafferty: This is a more prudent approach – as long as the financial health of the parent is not compromised. The main reason is that the risk is limited to the amount of money offered and the liquidity of the parent company to provide it. This approach can be a win-win situation for all parties. The parents meet the need for assistance while the family member becomes a homeowner.
Geller: In some cases, this works better because you’re not tied to the loan for the next 30 years. On the other hand, if your child is not eligible for a mortgage without your co-signature, paying part of the down payment will not help them.
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Q: Are there legal steps to protect parents’ finances and creditworthiness?
McCafferty: Generally, the only way for the co-signer to remove their name from the loan is for the borrower to refinance. Remember that a mortgage is a contract. Once signed, it’s hard to undo.
Some precautions to keep in mind:
1. Act like a bank. Set criteria for the borrower you are helping. For example, check their credit report or ask about their employment situation or check their monthly expenses.
2. Review the agreement. This seems obvious, but make sure you know what you’re signing.
3. Be the primary holder (not secondary). This gives you more control. Account statements go to you. You can then pick it up from the second borrower.
4. Collateralize the deal. Set conditions for missed payments. For example, get the second set of keys for your car. Missed payments have penalties.
5. Create your own contract. Create a promissory note that discusses the obligations, costs, and consequences the borrower will have if they default.
6. Consider a trust. Work with an attorney to protect your personal assets with a trust.
7. Establish an exit strategy. For example, 12 to 24 months may be appropriate. At this point, refinancing should occur. Set the right expectations at the beginning.
Geller: There are two things I recommend. One is to sign an agreement with your child that your child will agree to refinance the mortgage loan once they become eligible for a mortgage and to exclude you from co-signing it. This ensures that you are not tied to the loan for longer than necessary.
Second, I strongly recommend asking the bank to mail mortgage statements to your address as well. Banks generally only transmit mortgage statements to a co-signer if the co-signer expressly requests it. To stay on top of the loan and ensure payments are made on time, be sure to request monthly bank statements and review them each month.
Q: Any other tips for parents?
McCafferty: It’s understandable that parents want to help their children – especially in the current real estate market. If you work with a financial planner or wealth advisor, involve them in the process. They can provide relevant experiences and objective perspectives. In the end, understand the monthly payment obligations and whether they can be easily met by the borrower. Most importantly – use your common sense and don’t allow a family member to get ahead of themselves.
Geller: In some cases, it’s better to say “no” to co-signing. I know of a few cases of close family members not speaking to each other because a joint signing goes wrong. Sometimes the best thing you can do for your relationship with your child is say “no” to a joint signature. It will be better for you and your child.