Homeownership is a cornerstone of the American Dream for most, but many millennials are finding it difficult to afford to buy in.
Overall, millennials are still far behind in homeownership compared to previous generations were at their age. Only 39.1% of millennials lived in a home they owned in 2016 compared with 63.2% of Gen Xers, according to an analysis by Trulia Economist Felipe Chacón.
Student debt and stagnant incomes could share some of the blame. Millennials earn 78.2 cents for every dollar a Gen Xer earned at their age, Chacón found. Nearly half of millennial homebuyers report carrying student loan debt, according to the 2016 National Association of Realtors Home Buyer and Seller Generational Trends survey. They carry a median loan balance of $25,000.
Loan officers have to take a borrower’s total debt picture into account when running their application, and it’s become increasingly hard to qualify for a mortgage with a vast amount of student debt.
When they can’t get approved for a mortgage, it’s common for homebuyers to seek out a co-signer for their loan. Often, that person is a parent.
Co-signing a child’s mortgage loan is a serious decision, and parents should weigh all of the risks before making any promises. We asked financial experts what risks are worth worrying about to help clear out the noise.
1. You’re on the hook if your kid stops making mortgage payments
When you co-sign a loan, you agree to be responsible for payments if the primary borrower defaults. If you’re expecting to retire during the life of the mortgage loan, co-signing is an even larger risk, as you may be living on fixed income.
Dublin, Ohio-based certified financial planner Mark Beaver says he’d be wary of a parent co-signing a mortgage for their adult child. “If they need a co-signer, it likely means they cannot afford the house, otherwise the bank wouldn’t require the co-signer,” says Beaver.
By co-signing, you effectively take on a risk the bank doesn’t want. And the list of potential scenarios in which your child may no longer be able to afford their house payments can be vast.
“What if your daughter marries a jerk and they get divorced, or he/she starts a business and loses money, or doesn’t pay their taxes. The risk is ‘what can happen that can make this blow up,’” says Troy, Mich.- based lawyer and Certified Financial Planner, Leon LaBrecque.
Bottom line: If you wouldn’t be able to comfortably afford the payments in case that happens, don’t co-sign.
2. You’re putting your credit at risk
A default isn’t the only event that could negatively affect your finances. The mortgage will show up on your credit report, too, even if you haven’t taken over payments. So, if your child so much as misses one payment, your credit score could take a hit.
This may not be the end of the world for an older parent who doesn’t anticipate needing any new lines of credit in the future, Beaver says, but it’s still wise to be cautious.
You might think your child is ready to become a homeowner, but a closer look at their finances may reveal they aren’t yet that financially mature. Don’t be afraid to ask about their income and spending habits. You should have a good idea of how your child handles their own finances before you agree to help them.
“Sure, we don’t want to meddle and pry into our children’s business; however, you are putting yourself financially on the line. They need to understand that and be open about their own habits,” says Andover, Mass.-based Certified Financial Planner John Barnes.
3. Your relationship with your child could change
Co-signing you child’s mortgage is bound to change the dynamics of your relationship. Your financial futures will be entangled for 15 to 30 years, depending on how long it takes them to pay off the loan.
Seal Beach, Calif.-based certified financial planner Howard Erman says not to let your feelings get in the way of making the correct decision for your budget. Think of how often you communicate and the depth and strength of your relationship with your child. If saying no might create serious tension in your relationship, you likely dodged a bullet.
“If your child conditions their love on getting money, then the parent has a much bigger problem,” says Erman.
Similarly, you should consider how your relationship would be affected if somehow your child ends up defaulting on the mortgage, leaving you to make payments to the bank.
4. You might need to let go of future borrowing plans
Co-signing adds the mortgage to the debts on your credit report, making it tougher for you to qualify for additional credit. If you dreamed of one day owning a vacation home, just know that a lender will have to consider your child’s mortgage as part of your overall debt-to-income ratio as well.
Although co-signing a large loan such as a mortgage generally puts a temporary crimp in your ability to borrow, keep in mind you may be affected differently based on the dollar amount of the mortgage loan and your own credit history and financial situation.
How to Say “No” to Co-signing Your Child’s Mortgage
There is a chance you’ll need to deny your child’s request to co-sign the loan. If you feel pressured to say yes, but really want to say no, Barnes suggests you say no and place the blame on a financial adviser.
“Having [someone like] me say no is like a doctor telling a patient he or she can’t run the marathon until that ankle is healed. It is the same principle,” says Barnes.
He advises parents facing the decision to co-sign a loan for a family member to meet with a financial planner to analyze the situation and give a recommendation for action.
If you choose to take the blame yourself, you may want to take the time to explain your reasoning to your child if you feel it’s warranted. If you said no based on something they can change, give them a plan to follow to get a “yes” from you instead.
LaBrecque suggests that parents who want to help out but don’t want to take on the risks of co-signing instead give the child a down payment and treat it as an advance in the estate plan. So if you “gift” your kid $30,000 to make the down payment, you would reduce their inheritance by $30,000.
The “gift the down payment” method grants you some additional benefits too.
“[The] method has a more positive parent/child relationship than the potential awkwardness of Thanksgiving with the kid(s) and late payments on the mortgage. Also, the ‘down payment gift’ is a quick victory. The kid’s now made their bed with the mortgage; let them sleep in it,” says LaBrecque.
Similarly, you could choose to help your child pay down their debts, so they’ll be in a better position to get approved on their own.
If you must say no, try to do so in a way that will motivate them toward the goal rather than deflate them. Erman recommends lovingly explaining to your child how important it is for them to be able to achieve this success on their own.
How to Protect Yourself as Co-signer
The best way to protect yourself against the risks of co-signing is to have a backup plan.
“If a child is responsible with money, then I generally do not see a problem with co-signing a loan, provided insurance is in place to protect the co-signer (the parent),” says Barnes.
He adds parents should make sure the child, the primary borrower, has life insurance and disability insurance in case the widowed son or daughter-in-law still needs to live in the home, or your child becomes disabled and is unable to work.
The insurance payments will also help to protect your own credit history and future borrowing power in case your child dies or becomes disabled. But these protections would be useless in the event your child loses their job.
If that happens, “insurance will not pay your bill unfortunately, so even if you are well insured, budgeting is vitally important,” Beaver says.
If you choose to take on the risk and co-sign, Barnes says to make sure you and your child have a plan in place that details payment, when to sell, and what would happen if your child is unable to make payments for any reason.
Additionally, LaBrecque recommends you get your name on the deed. Don’t forget to address present or future spouses. Ask your lawyer about having both kids sign back a quit-claim deed to the parent. If you get one, he says, you’ll be protected in case the marriage goes south, or payments are made late, because you would be able to remove a potential ex off the note.