Stock Rental lease agreement contract
Co-signing a loan can be a good financial strategy that helps them build credit. Or is it? Image Credit: Shutterstock

If you're the parent of a young adult, you may be asked to co-sign for a car loan or an apartment lease. Before you agree, know what's at stake – you could be putting your own financial security at risk.

What does it mean to co-sign for a loan?
When you co-sign a loan, you promise to pay off the loan in the event the primary borrower is unable to pay off the loan. A co-signer becomes necessary when the person applying for the loan doesn't have sufficient credit history, reliability or income to get the loan on his own.


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What co-signing a loan means in your situation

When you co-sign, you become fully responsible for someone else's debt. If they don't pay, you're on the hook.

Even if they pay on time, being a co-signer can make it harder for you to qualify for credit, because that debt is considered yours and creditors could see you as overextended. If your child doesn't pay on time, you could suffer significant damage to your credit score.

When you put your name on someone else's debt, it's smart to make sure you can access account information so you know if trouble is brewing. “You need to be prepared for the worst-case scenario, which is the other person is unable to pay and they ghost you,” says Kelley Long, a US-based certified accountant.

While it has its pitfalls, co-signing can sometimes be smart. Here’s a real-life example how it can be.

An example how it can be a smart move to co-sign your adult child's loan
US-based Lynnette Khalfani-Cox co-signed for a condo with her daughter, now 23, four years ago. “It was pure strategy,” she said, while adding that it was a family decision.

Homeownership helped Khalfani-Cox’s daughter focus on college tuition and other career-related costs. Khalfani-Cox and her husband, Earl, covered the down payment and closing costs – a total of about $25,000 (Dh91,830). They saved that much on tuition the first year.

With the rent from roommates' covering the monthly loan payment, their daughter spent three years living rent-free. And on-time mortgage payments helped her establish good credit. She graduated, got married and got a job, then she and her husband insisted on paying rent. The young couple are looking for a bigger place, and Khalfani-Cox intends to rent the condo out.

Why does your child need a co-signer for a loan?

Lenders want co-signers when they can't approve someone's application on its own merits. Reasons are typically:

• Little or no credit history.

• Too little income or too much debt.

• A history of mismanaging credit.

When co-signing for an adult child goes wrong, it's often because the young adult does not pay as the parent expected, added Long, who also heads a personal finance establishment. Relationships can then be damaged and credit trashed.

This is why Long recommends initially spelling out issues such as:

• Who will make the payments?

What to do if someone can't make a payment? (as it would affect both the borrower's and co-signer's credit scores).

Whether and when the loan will be refinanced into the adult child's name.

Stock Rental lease agreement contract
Picture used for illustrative purposes.

Knowing when can you say yes to your child on co-signing a loan

“If it's a payment that you are going to make anyway, or are prepared to make, then co-signing isn't as risky,” said Long. For instance, if you planned to pay for a car or student loans anyway, you might have the young adult apply. When their name is on the loan, the payments you make help them build credit.

There are qualified yeses as well. Long suggests spreading out responsibility as much as you can if you co-sign a lease. That could mean:

• Asking for individual leases and co-signers for roommates. Co-signing for only your child's portion protects you if roommates skip out on rent, damage property, etc.

• Splitting up responsibility for utilities. You don't want to be responsible for all of them.

Knowing when can you say no to your child on co-signing a loan

Khalfani-Cox says she's generally against co-signing. “Many people who are seeking a co-signer have not proved themselves as creditworthy or they've had kind of poor credit behaviours in the past. If the bank isn't willing to loan to them, I'm kind of like, ‘Why should you?’”

If you see signs that your young adult won't handle credit responsibly, pay attention. If co-signing would jeopardise your financial security, a gentle “no” along with an offer to help some other way – like a one-time cash gift or providing rides – may be wiser.