A recent survey conducted by the credit reporting agency Experian found that approximately two-thirds of all millennials (those born between the late 1970s and mid-1990s) have used a cosigner at least once, usually a parent.
That’s a lot, but it’s not exactly surprising.
To back up a little, cosigning a loan or application (usually for housing or utilities) means that you’re essentially acting as a guarantor on the transaction – if the borrower or applicant does not fulfill the terms of the agreement (basically doesn’t make the necessary payments) you’re on the hook. You either have to make the payments yourself or your credit takes a hit, the same as if you have taken out a loan yourself and neglected to make payments.
The most common reason why anyone would cosign on a loan or credit card or rental application is because the actual borrower isn’t a strong enough candidate on their own. They may have poor credit. Their income may not be sufficient. There can be any number of reasons. The cosigner is using their good name (and good credit, most often) to back-up the transaction. That’s why the majority of cosigners are parents. They can use their credit history and established incomes to help their children receive better loan terms or find better housing options.
As lenders have moved to reduce their risk (especially in the fallout of the Great Recession of 2008) they’ve tightened their standards for receiving loans and favorable loan terms. If young adults haven’t already been working on building their credit history they may find themselves facing an uphill climb. In fact, according the Experian survey, the two most common reasons millennials seek cosigners are for student loans (35 percent) and for residential leases (32 percent).
Therefore, it’s pretty understandable why parents jump into the breach to help their children. If they feel they can leverage their credit history to help their children obtain student loans and an apartment in a preferred neighborhood, they’ll do it – even if it’s not in their own best interests.
Why not cosign?
In general, the advice most experts give regarding cosigning is, “Just don’t do it.” In fact, Bankrate.com has 10 pretty strong reasons why you should never cosign, including the fact that lenders are more likely to sue the cosigner to recover a defaulted loan. Why? Because the cosigner is equally responsible and – by virtue of being the cosigner – they’re much more likely to have the financial assets available to repay the defaulted loan.
Basically, cosigning means becoming directly impacted by a loan or agreement that you don’t directly control. Approximately 8 percent of contracts featuring a cosigner end up with missed payments or completely defaulting. Of those accounts in bad standing, 17 percent of the time the cosigner is not aware that there are issues with the account, and 12 percent of the time the cosigner sees their credit score drop as a result.
Yes or No?
As Money Talks News’ Krystal Steinmetz writes, in discussing Experian’s findings, “We’ve said it before, and we’ll say it again – co-signing is not a good idea, even if you’re trying to help out your child…Fellow millennials, if you can’t get a loan or apartment on your own, maybe you should just accept it, move on and claim your financial independence.”
That’s a pretty hard line, and one, I think, parents’ might have a difficult time sticking to. After all, when it comes to your children, most parents are inclined to help, however they’re able.
The solution might be something in between. Avoid cosigning whenever possible. Look for alternate solutions. If cosigning is the difference between a great apartment and a pretty good apartment, then pretty good needs to be good enough. If it’s the difference between any apartment and no apartment at all, then consider co-signing with the condition that you maintain an open monthly dialogue about finances to help ensure that the renter never falls behind.
Cosigning should be left as a last resort, but it can be an acceptable option if both parties are willing to be open and honest about money. If you trust your children enough to cosign on a loan, then they need to trust you enough to let you know that they’re struggling to make payments and why that is. Make money a safe topic of discussion from an early age and you’re less likely to run into the kind of unpleasant surprises that cosigning can lead to.