March 5, 2018

How Your Child’s Debt Can Affect You

Life brings many milestones, such as buying your first car or home, graduating college, and starting a family. Unfortunately, many of these milestones can also come with significant costs.

While you may be very capable of managing your own debt, have you ever considered how your child’s debt can affect you? Cosigning a loan for your child, whether it’s for a car, home, student loan, or any other type of personal loan, will affect your finances just as much as your child’s. Because of this, it’s important to understand all of the potential consequences of being a cosigner before agreeing to be one.

1) Debt-to-Income Ratio

When you co-sign a loan, it increases your debt-to-income ratio—the total amount of your monthly debts divided by your gross monthly income. This could become an issue if you ever need to take out a new loan, or even refinance an existing loan, since lenders look at debt-to-income ratios when determining loan qualifications.

2) Credit Score

According to the Federal Trade Commission, when you co-sign a loan for your child, you are being asked to guarantee the debt. Essentially, the loan is just as much your responsibility as it is your child’s. If your child defaults on his or her payments, you are responsible for the loan, as well as any late fees or possible collection costs. This will directly affect your credit score and show up on your credit report, not just your child’s.

3) Ongoing Liability

As a cosigner, you are typically tied to the debt until the entire balance is paid off. In some cases, you can request that the lender release you from liability on the loan, but this is not always an option and is more common with student loans than other types.

The only other way to remove yourself would be to refinance the loan, in which case your child would have to requalify for the loan on his or her own.

4) Unforeseen Events

While no parent wants to think about something bad happening to their child, the reality is that these things do happen. If your child becomes disabled, he or she may no longer be able to work and continue making their loan payments. In this circumstance, disability income insurance can protect the cosigner from having to take over the payments.

If the truly unthinkable happens and your child dies, any loan you have cosigned may become your responsibility. In some cases, this may mean that the total amount owed would be due in full upon the child’s death. A life insurance policy on the life of your child is a dependable way to protect yourself form an unforeseen tragedy resulting in an additional financial burden.

Term life insurance can be a good option as it provides temporary life insurance coverage for a specified period of time. The term period could be selected to coincide with the loan repayment schedule. Permanent life insurance is another option as it would provide coverage for your child’s entire lifetime. This type of policy can also serve as a great gift.

While co-signing a loan does come with its share of risk, it can also be very rewarding to help out your child. We hope that by knowing all your options and understanding the potential consequences, you will have all the information you need to make an informed decision.