Parents Co-signing Debts. The Pros & the Cons (Mostly Cons)
This was also covered on Debt Free Wealth Radio. Listen as you read.
Young adults moving out into the world often do not have the credit required to lease their first apartment, finance their first car, or get college loans.
Loving parents are often co-signing debt for kids without a second thought. In this show, we will discuss the pros and cons of this, as well as explore healthy ways to help our kids become financially savvy and independent.
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15 years ago, my grandmother, God rest her soul, had co-signed a furniture store debt for her Ex daughter-in-law. She refused to pay the debt when things heated up between her and her former husband, and my grandmother was hounded by the debt collectors. At first she was confounded by the calls because when she signed those papers, she did not read anything, she did not even understand what she was doing. She trusted this person and wanted to help and signed whatever was put in front of her. In the end, she negotiated a percentage of the debt and paid that back and only because she knew her own credit was at stake. That of course strained the already tense relationship between herself, her ex-daughter in law, and her son.
In fact many family relationships are enduring great strain over what started out as a loving gesture.
Here is a correspondence that came to me recently:
Dear Debt Free Wealth Money Coach: I co-signed some private student loans for one of my kids. She graduated two years ago with about $65,000 in student debt, including federal and private loans. Like many other recent graduates, she has had a difficult time finding a job in her area of study. She works two part-time gigs as a waitress and some babysitting. She had to move back in with me, and according to what she says, she is only making a gross of $10,000 annually. I also co-signed her apartment lease which she moved out of after losing a $10/hour full time job, and I also co-signed her car note, and she just turned back in the car, because they were getting ready to repossess it anyway. Things have gotten very tough around here, and because she’s back living with me now, we fight a lot too. To protect my credit, I have been helping her make the agreed reduced payments and she has gotten deferments and income-based repayment plans.
Because of this, I have not been able to contribute to my retirement fund at all, and may even have to dip into it, or worse, I am worried about whether these debts she has can wipe me out if the creditors keep this up. I am frustrated about this whole situation. Se is too young for a bankruptcy, but she contacted a lawyer anyway who dissuaded her from that option because the biggest portion of her debt is this student debt and most of it wont go away with the bankruptcy anyway. What can I do?
Before I get into answering this, let me say, this person’s situation is not unique.
Many students are starting or heading back to college right now, and even as I record this, parents and grandparents are out there co-signing debt for the, and signing their life and retirement away all in the good intention of helping their young people get a start in the world. Some are not so young, and parents are still co-signing debts for mortgages and car notes. Co-signing debt your boyfriend or girlfriend’s debt is also popular as a gesture of further investing in the relationship.
My Recommendation…Avoid Co-Signing Debt
Here is what I have to say to all of the above. DON’T DO IT! And if you already have, even before it becomes a problem (and it is very likely to) begin to work on freeing yourself from that debt as soon as possible.
Debt Free Wealth Radio, and my life’s mission is hinged on the core Bible verse of Romans 13:8, and reading from the KJV it reads
Romans 13:8 (KJV)
8 Owe no man any thing, but to love one another: for he that loveth another hath fulfilled the law.
Whether you are a Christian or not, or even see the Bible as nothing more than a good library book, very few would question the wisdom of those words I just read.
So let me convert those Bible verses to today’s vernacular:
Romans 13:8 Owe no man anything but love, translates to – Owe no one at all, and if you do owe, make sure it is only love that you owe.
Here are some other Bible verses I want to add to that in support:
Proverbs 22:27 (NIV)
27 if you lack the means to pay,
your very bed will be snatched from under you.
Translates to: You will be forced into foreclosure and your property will be repossessed, even the very bed you sleep on you will lose, if you can’t pay your debt.
Proverbs 6:1-5 (KJV)
6 My son, if thou be surety for thy friend, if thou hast stricken thy hand with a stranger,
2 Thou art snared with the words of thy mouth, thou art taken with the words of thy mouth.
3 Do this now, my son, and deliver thyself, when thou art come into the hand of thy friend; go, humble thyself, and make sure thy friend.
4 Give not sleep to thine eyes, nor slumber to thine eyelids.
5 Deliver thyself as a roe from the hand of the hunter, and as a bird from the hand of the fowler.
Translates to: If you have already co-signed a debt, or promised to pay on behalf of someone else, even for a friend; do not rest until you find a way to clear yourself of the responsibility and save yourself from the debt collector who will hunt you down.
So for those of you who claim Christianity and the infallibility of the Bible, I hope you read the warnings handed down to us. If you are in your devotion time and reading through the Word, you would have seen it and it stands as witness against you. So if you are among those crying because of this oversight, remember, ignorance of the law is no excuse. You had the warnings. I hope you heeded them or will heed them.
Now, I have two students in college today. My eldest had her college time interrupted with marriage and children, however she is back now continuing her degree. Beautiful girl that she was, she was Prom queen, very popular, and although she was smart, she was not consistent with her grades. She did not earn any scholarships, so she is financing school through the available federal grant, the Pell, private loans, and out of pocket expense. We have not co-signed anything for her. She will progress as she sees fit, but she knows not to use any of that loan money for living expenses, so she will limit her debt exposure as much as she can. As a family, we would rather chip in cash outright to help her pay for books etc, than co-sign anything. We know better, and with all my preaching on debt free wealth, my entire family has joined me in this Biblical position of owing no one if at all possible, and where debt is concerned, to neither seek a co-signer, nor to become one.
My second child is in his 3rd year at an ivy league university. He was consistent in his grades during school and received a full-ride academic scholarship to Stanford University as well as additional private scholarship that put money in his pocket. He recently was selected from a pool of applicants to be a Resident Assistant on his dorm, so in addition to not having any direct school expenses, he now earns enough money to buy him the trips and entertain the girls and so on.
If it were not for my exposure to this Biblical teaching early on, I can guarantee that I too would have joined all the other parents out there, co-signing debt via my signature to get my kids off to a start in life.
After all, fresh out of high school, or even early on in your college years, a student’s credit is zero or too low for lenders and the Lenders encourage those students to get their parents to sign. The Lenders are very aware of the risk of non-payment and want parents and grand parents co-signing debt so they bear the responsibility for the debt for students. Sometimes they bear the entire weight of the debt, because the loan and the amount available was decided solely on the credit worthiness of the co-signer, since the student has no credit.
So let me answer the person who wrote in about the student debt. I hope you remember the scenario about the $65K in student loan, car note, and apartment lease the mom all co-signed on.
Remember, I do not not give financial advice. I am not telling you what to do, I do not even know who is specifically reading this, and every circumstance and response is different. This is general money education. As always, please see your financial adviser who has direct access to your personal numbers and situation and will speak specifically to your situation.
All the problems mentioned in the correspondence could have been avoided with pre-planning. It is a pity she had not pre-planned college funds from the time her daughter was a child since she obviously did not mind paying for it in the long run. Also, students should, when possible, work and save toward college, keep their grades up to increase their chances of qualifying for scholarships etc. Also, if this mom had been listening to some of my former shows and protected her assets in strategic Trusts, she would be less exposed to personal loss because she would not appear to have very much to take if it was properly protected via Trusts. However, I am going to assume none of those things were in place because they are in the hot water that they are, so. Let’s take that note at face value and address the situation where they are now as generically as possible.
My Answer: These loans typically can’t be shed in Bankruptcy Court and there is no statute of limitations on how long collectors can pursue the debt. Even your Social Security benefits aren’t safe: In 2005, the U.S. Supreme Court upheld the government’s ability to offset Social Security disability and retirement benefits when a borrower has defaulted on student loans. In fact, tax time is just around the corner and some people will not get what their accountant says should be their tax return because the government has been known to reach in and take that to apply to old, unpaid, student debt.
Let’s separate out federal and private loan options.
“Income-based repayment plans can provide some relief with the federal loans. This repayment option limits the required payment to 15% of the student’s discretionary income, and the balance can be forgiven after 25 years,” according to Mark Kantrowitz, publisher of the FinAid.org financial aid site. “If the student has no income, her required payment would fall to zero. Unlike deferment and forbearance plans, which have three-year limits, the income-based repayment allows zero payments indefinitely. She should investigate signing up for such plans for all her federal loans.”
The private loans you cosigned have far fewer repayment options. Some have forbearance and deferment options, while others do not. You may be able to negotiate a lower payment temporarily, or you may not. Because private student loans’ rates and terms aren’t regulated the same way federal loans’ are, they’re considered much riskier. Using them is kind of like paying for college with credit cards, except unlike with credit cards, the debt can’t be discharged.
It’s too late to tell this person he/she shouldn’t have been co-signing debts if you did not plan to, or are unable to take over the payments.
The other option is to try to negotiate an affordable repayment plan with the private lenders, which is no easy task. For more information, visit the Student Loan Borrower Assistance program at http://www.studentloanborrowerassistance.org.
In RARE cases, you may be able to negotiate for a Co-Signer Release, and if you have a responsible student, this is the way to go. A Cosigner release is the ability to remove the cosigner from a loan agreement at a future date. The reason why I say Co-Signer Releases are rare is because of the 3 requirements that have to be in place consistently for it to kick in:
- Minimum number of on time principal and interest payments: The borrower must demonstrate solid repayment habits by making a specified number of full loan payments once they enter normal repayment mode after graduation.
- Primary borrower has strong enough credit: Before a cosigner will be released from a loan application, generally the primary borrower must have strong enough credit to be “approved” first. This means the primary borrower would need to meet credit requirements to be approved for this loan without a cosigner. Primary borrower credit must be in good shape, and they must be earning a minimum income requirement.
- Submit a written request for release: Once the borrower meets the minimum requirements, they need to submit the request to the loan provider before the review is initiated. Lenders do not remove cosigners until the request is submitted and all credit and repayment requirements are met, so make sure to follow up with this last requirement.
Source: Co-signer RELEASE info http://www.custudentloans.org/2012/07/16/cosigner-release-on-private-student-loan-applications/
While student loans, car-notes, and apartment leases top the charts for parents co-signing debt; parents and grandparents, may find they are still co-signing for their family members even later into adulthood, later twenties, early thirties, parents The biggest one that adult children ask for help on is mortgages. Family becomes more emotionally inclined and willing to sign shortly after they have already footed the bill for an expensive wedding, or after the birth of their first grandchild. However, the slew of foreclosures in the economic earthquake as I like to call it of mid 2006 to early 2011, has had many of those well intentioned retirees to sob deeply as their retirement now looks grim.
Co-signing mortgage debt has recently been a bad debt deal for parents and grandparents recently. http://www.deadlinenews.com/2011/12/16/mortgage-co-signing-pros-cons/ If the homebuyer defaults on the loan for any reason, the lender can turn to the co-signer without investigating other options of collection.
Another place parents and grandparents lose their life savings is in prison bail money. Many of those wayward enough to get into trouble, tend to stay in trouble and while I can totally empathize with a parent wanting to spare their children the horrors of jail, the reason why there is a bail bonds business (and I know a few bail bondsmen that give me the inside scoop on their wealth) is because they know a high percentage of these people will default and for a token sum, bail bondsmen become the instant owner of your property. Your car, home, boat, whatever you put up as collateral for the person’s prison release.
Whatever you do, don’t use your property to secure another person’s loan. If someone borrows against your car and doesn’t repay, the lender will repossess your vehicle. The fact that you are just a cosigner and not the original borrower will make no difference to the collection agent or repo man. http://credit.org/blog/before-you-cosign-consider-the-consequences/
A Bankruptcy myth I want to kill right now too, is that a bankruptcy clears the person co-signing debt for another. If the person you co-signed for declares bankruptcy THEY are relieved of the debt not you. Let me repeat that. If the person you co-signed for declares bankruptcy THEY are relieved of the debt not you.
A co-signer can and will be held legally liable for any debts not paid through the bankruptcy. If a personal loan is discharged during Chapter 7 proceedings, the original loan holder no longer has to pay the creditor. The co-signer, however, must repay the full amount to the creditor and bears 100% of the burden to do so
Read more: What Happens to a Cosigned Loan in a Bankruptcy? | eHow.com http://www.ehow.com/about_6392459_happens-cosigned-loan-bankruptcy_.html#ixzz2HelpH2vc
Bankruptcy doesn’t eliminate debt, it extinguishes personal liability for debt. Co-signing for debt is nothing more than attaching personal liability to a debt. A co-signor effectively says: “I will pay if they don’t.”
How to Avoid Being Asked About Co-Signing Debt by Young Adult Family Members
So, now I hope I have established that co-signing debt should be avoided; and if you have already done it, to work tirelessly toward clearing your name from responsibility of that debt. So, what are some healthy ways to help our kids become financially savvy and independent?
Honestly, the younger you start the better, and the BEST teaching strategy for our young children is personal demonstration of a commitment to being debt free.
Having a transparent integrity before your children, letting them know that you are living within a budget, and saying no to things if it means going over the budget, or asking them to wait till next month for example, is the best way to develop these same habits in them.
If you give an allowance (and I know that the whole topic of giving children an allowance can become a heated debate, so I wont go there) – so ASSUMING you do, regardless of whether that allowance is tied to chores or not, teach them to create a budget and spending goals with their allowance.
If they are already heading out to college or still young adults, pay attention to their work ethic. Irresponsibility and youthfulness goes hand in hand, so don’t have adult level standards for them on that, but in the same vein, do not blindly give them credit cards ignoring the irresponsibility factor in the equation.
Now I got trapped into a debt for my daughter quite sneakily I think, through no fault of her own.
When she was 17 and opened her first bank account, she got a debit card but that card did not have the visa or mastercard logo on it, as is customary with most debit cards. Now, I said DEBIT card not credit card. You all know that debit cards are limited to the funds in your account, maybe with limited overdraft protection, but limited for the most part to the funds in your account. So when she realized that she could not swipe her cards at her favorite department stores, or pay her cell phone bill online with that debit card, the bank told her that she could get the debit card with the logo if I signed some paperwork at the bank.
Since this was a checking account, and her debit card, I did so without hesitation. Well, my daughter was recently the victim of identity theft, however we realized it and as far as we can see, the damage was less than $2000 when we interrupted it. However, because her bank account was linked to the damage, and the bank claims they could not established the trail of the identity theft, she got saddled with the internet loan taken out at a remote location that the bank had somehow had monies withdrawn from her account sending it into overdraft of almost $1000. The creditors of course did their due diligence, realized my 22 year old does not have the ability to pay, has not paid, and they are calling me. Well, I can tell you, as much as I know as a fact this debt did not originate with her, the debt is also not mine, and while I will help her, I am working with her to step up to this unfortunate situation and clear the ding on both of our credit.
Because you KNOW this negative report is noted on the original borrower, and the person co-signing the debt
This reason alone is why I also recommend that married couples do not share credit debt. Bank accounts – yes! Debt -NO! They can be noted as an authorized user, but there is no point putting the same debt burden on both credit ratings. Share bank account and money, but not the debt. Put both names on the title of the newly purchased home, but not the mortgage note. Anyway, that is the content for another blog, at another time.
I helped my son has obtain a credit card in his own name when he headed off to college. The credit card only offered him a $300 limit and I did that for 3 reasons, 1 to help him begin to establish a credit history, have a strategy to teach him about developing healthy credit, and to observe how he would handle this responsibility. Now, there were many months I had to pay the card for him, but there is an open line of communication between us as to the state of his finances as he approaches due date. For the most part he pays more than the minimum and when possible the whole amount spent – he pays off and recycles that credit again and again. The thing is, while I did not tell him this, I was fully prepared to pay that card off if he messed up, but if I did, the caveat would be that on a 3-way call, he authorizes the closing of that account so once I pay it off, he cannot spend it again. So far, he has made me proud, and on his own, he qualified for his second credit card from his bank for almost $5000. Now, while I firmly believe we should owe no man any debt but love, the fact is, in the USA credit and a credit history is a vital financial matter. The day will come when he wants to buy his car, or a home, or start a business, and with a responsible approach to debt, he will need credit.
In fact, we attempted to live credit card free for a while only to discover the problem in renting cars and booking hotel rooms without a credit card. Did you know, car rental and hotels do not want to willingly take your visa logoed debit card? They insist on a credit card. So we do carry two cards in my family, but if we use them, we pay the balances off in full at the end of the month
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