We asked John McCafferty, director of financial planning for Edelman Financial Engines in Alexandria, Va., and Chaim Geller, financial advisor and founder of Help Me Build Credit in Brooklyn, for their advice to parents. Both responded via email and their comments have been edited.
A big concern about co-signing is that as a co-signer, the parent has no rights to the property but takes responsibility for all of the debt, McCafferty wrote.
Q: When should parents consider co-signing a mortgage for their adult children?
McCafferty: Parents step in when an adult child is not in a financial position to qualify for a mortgage on their own. There are pros and cons to being a co-signer. I would only suggest a parent go ahead if it is very clear that their own financial health, like their retirement security, will not be compromised.
Gel: Co-signing is one of the greatest favors a person can give their child. But co-signing isn’t for everyone. To make sure you won’t regret it, you need to understand the seriousness of co-signing. It has to make financial sense and you have to have enough confidence in your child. If you don’t, co-signing can be a devastating mistake, with serious consequences. It can ruin you financially, mess up your credit, and worse, cause a rift in your relationship.
Q: Are there any red flags about when it’s a bad idea to co-sign a mortgage?
McCafferty: Yes, the fact that co-signing is required is a red flag, and it should at least make the parties involved ask themselves: “Why is co-signing necessary?” Although the answer may be obvious, it is important to go through the verification process. Mom and dad can be expected to help out, especially if they’ve taken care of most other financial obligations so far.
But there are many reasons why this important responsibility would not be in their best interest, and they should discuss all the variables. For example, what is the professional trajectory of the borrower? Is he or she married? If yes, what is the professional background of the spouse? Do they have children? The list of questions can be long and the risks are many. Meanwhile, the child takes advantage of the parent’s financial situation to buy something he may not be able to afford. For the parent, this creates a higher debt-to-income ratio (DTI), which could negatively impact their credit rating and future borrowing potential. Relationships could also be affected if difficulties arise during payments.
Through this lens, I encourage common sense and don’t let the family relationship cloud any thinking. The essential question I ask clients is: would you accept this type of arrangement if your child was not involved?
Gel: Young adults can often have unrealistic dreams, and your kids may dream of buying a house they can’t afford. Before you co-sign for your kids, sit down with them and discuss their finances. What is their income? What are their monthly expenses? How much do they spend on groceries, restaurants, etc.? ? Do they have monthly car payments? This should help you see if you feel comfortable that the mortgage is affordable for them. Leave some financial leeway for unexpected expenses. If you feel like they’re overreacting and you’re concerned that they won’t be able to pay the mortgage payments, politely explain that you’re recommending them to find a more affordable home, or they may kick you out of the co-sign.
Q: How does co-signing work? Do parents have to pay anything at closing?
McCafferty: A cosigner helps a borrower qualify for a mortgage loan by agreeing to repay the loan if the borrower stops making payments. As a co-signer, you have no interest in the house and your name does not appear on the title deed. An ideal co-signer will have abundant income, excellent credit, and a healthy debt-to-income ratio.
Co-signers complete a home loan application as part of the process.
Once the lender’s conditions 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 outlines all of the most important terms of the loan.
If the borrower does not have sufficient funds at closing, the co-signer may be required to cover any down payment, closing costs and related additional costs.
Q: Is it a better option to help with the deposit than to co-sign? Why or why not?
McCafferty: This is a more conservative approach, as long as the parent’s financial health 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 for all parties. Parents satisfy the need to help while the family member becomes the owner.
Gel: In some cases, this will work better because you won’t be tied to the loan for the next 30 years or so. On the other hand, if your child is not eligible for the mortgage without your co-signature, paying part of the deposit will not help them.
Q: Are there legal measures that protect parents’ finances and credit?
McCafferty: Generally, the only way the co-signer can get their name on the loan is if the borrower refinances. Remember that a mortgage is a contract. Once it’s signed, it’s hard to undo.
A few precautions to take:
1. Act like a bank. Establish criteria for the borrower you are helping. For example, review their credit report or ask about their employment status, or review their monthly expenses.
2. Review the agreement. It sounds obvious, but make sure you know what you’re signing.
3. Be the primary (not secondary) cardholder. This will give you more control. Statements will be sent to you. You can then collect from the secondary borrower.
4. Collateralize the transaction. Set conditions for missed payments. For example, get the second set of their car keys. Missed payments result in penalties.
5. Create your own contract. Create a promissory note that discusses the obligations, costs, and consequences the borrower will have in the event of default.
6. Consider a trust. Work with a legal professional to protect your personal assets using a trust.
7. Establish an exit strategy. For example, 12 to 24 months may be suitable. At this point, a refinance should take place. Set appropriate expectations at the start.
Gel: There are two things I recommend. One is to sign an agreement with your child where your child agrees to refinance the mortgage as soon as they become eligible for the mortgage and remove you from the co-signer. This will ensure that you are not tied to the loan longer than necessary.
Second, I highly recommend asking the bank to send the mortgage statements to your address as well. Banks usually only send mortgage statements to a co-signer if the co-signer explicitly requests it. For you to be on top of the loan and ensure payments are made on time, be sure to ask for monthly statements and review them monthly.
Q: Any other tips for parents?
McCafferty: It’s understandable when a parent wants to help their children, especially in today’s real estate market. If you’re working with a financial planner or wealth advisor, include them in the process. They can offer relevant experience and an objective perspective. Ultimately, understand the monthly payment obligations and whether they can be comfortably met by the borrower. Most important – use common sense and don’t let any family member get in over his head.
Gel: In some cases, it is better to say “no” to co-signing. I know of a few cases of close family members who are not on good terms because of a co-signing that goes sour. So sometimes the best thing you can do for your relationship with your child is to say “no” to co-signing. It will be better for you and for your child.