Loan Co-signers Beware
Adulthood life often starts with having more financial obligations and responsibilities. One can say it begins when you finally move out of your parents house and start paying your own bills. But for that to happen in this day and age, it seems that many young adults still need their parents’ help, or well…their parents’ signatures.
A recent study by Experian Consumer Services, show that nearly two-thirds of millennials (In the survey, millennials were define as those ages between 18 to 30) have used a co-signer to rent an apartment, take out student loans or to qualify for other kinds of debt. About three-fourths of millennials admitted they would ask their parents to co-sign for them in the future.
“I don’t have hard and fast data that show co-signing is growing, but certainly it’s very prevalent these days,” said Becky Frost, senior manager of consumer education for Experian. This was the first year the study was conducted.
Co-signing is when a parent or individual guarantees a debt on your behalf. Although you cover the bills, the co-signer is on the hook if you fail to pay. Given what’s at stake, most financial planners caution against it.
“Adult children should ask their parents to co-sign only if they absolutely need to, and parents should agree to co-sign only if they absolutely could afford to make the debt payments,” said Som Hanvanich, a financial planner in Kettering, Ohio.
And in spite of the possible repercussions of co-singing loans, the Experian survey shows how this process is still very common. Sallie Mae reports that around 90% of customers who take out its “Smart Option Loan”, a type of private student loan, have a co-signer.
And as national vacancy rates for apartments decline and rents rise, the number of renters needing co-signers has grown. Waterton Residential, a company that manages apartment communities throughout the U.S., says the number of applicants who needed a co-signer to qualify for a lease grew by 30% from 2012 to 2013.
Young adults who don’t have long credit histories or big salaries may get better loan terms with a co-signer. At Sallie Mae, for example, students who take out a private student loan with a creditworthy co-signer reduce their interest rate, on average, by more than 1.5 percentage points.
But if you do ask a parent or relative to co-sign, proceed with caution:
Set up a budget. Before you take out the loan, draft a plan of how you will pay the bills.
“The parent and child should create a budget and review how payments will be made,” said Michael Solari, a financial planner in Bedford, N.H. “It’s also a good exercise for the child to see if the purchase is worth altering their lifestyle.”
Also, draft a plan for what would happen if you can’t pay. A lot of young adults who borrow with a co-signer actually manage their debt well. According to the study, roughly 8% of these accounts were in a bad standing because of late missed payments.
But anything can happen and you should be prepared in case trouble does take place. So you and your co-signer should have a plan in place for how the problem will be tackled.
“Parents should make this plan a condition of co-signing,” said Susan Bryant, vice president of marketing and media sales at Apartments.com.
Consider alternatives. Is there a way to get around needing a co-signer? With apartment rentals, for example, a landlord may waive the co-signer requirement if you provide a bigger deposit upfront (which your parents may be willing to help finance, if needed).
“Instead of one month’s rent, offer two,” Bryant said.
Set up an exit strategy. If you do end up needing a co-signer, know the rules about if and when a co-signer can be removed from the loan. Just beware that releasing a co-signer may not be easy.
A recent report by the Consumer Financial Protection Bureau, which analyzed thousands of private student loan complaints and debt collection complaints related to student loans, shows that borrowers often face obstacles when seeking to release a co-signer from a private student loan.
Also, the report found that if the co-signer dies or files for bankruptcy, you could suddenly owe the remaining balance of your student loan in full — or have your loan placed into an automatic default.
So make sure you understand all the consequences before asking a family member to co-sign for you, or if you happen to be the co-signer, be sure you’re ready to possibly end up with a damaged credit and having to repay the debt yourself!