Photo of a happy woman holding an Open sign in front her outdoor flower standAs your child heads off to college or starts life as an independent young adult, he or she will likely face new financial responsibilities, such as a car purchase, rent or college tuition payments. Given their lack of credit history, it may be difficult for them to obtain a loan without a parent or another adult cosigning the loan. Your natural inclination may be to help them out and sign the dotted line, but before you do, make sure you’re clear on the terms of the loan and what it may mean for your finances.

Cosign with your eyes wide open

Even though you may not consider it “your loan” if you cosign, lenders will identify you as one of the borrowers. That means you may be at risk if different circumstances arise. Keep in mind:

• If any of the balance remains unpaid by the borrower (in this scenario, your child), you as the cosigner will be required to repay it.
• If your child defaults or even misses one or two payments, it can damage your credit record.
• Even without a default, other lenders may look on the cosigned loan as an additional liability you will need to pay, which could also affect your credit record.
• In some states, the creditor has the right to collect payment from you, as the cosigner, without first trying to collect from your child.
• If you were to pass away, it could trigger “auto default” provisions in the loan contract. This would require your child to immediately pay the debt. Regulators discourage this practice, but it still exists in some loan agreements.

Steps to protect your position

Fortunately, there are often alternatives to cosigning a loan. For example, if your child is enrolled in college, he or she may be eligible for federal student loans or financial aid. Another option, if you can afford it, may be to lend your child money directly — thereby forgoing the paperwork and stipulations introduced by a third-party lender. If you decide to take this action, make sure you and your child have a clear and consistent understanding of the terms of the loan, including a repayment schedule that he or she will be accountable for sticking to. If you do decide to cosign a loan, take steps to help protect yourself:

• Read the fine print and understand the terms of the loan and the expectations of the lender.
• Avoid pledging property, such as a car, to secure the loan, as it could create additional risk.
• Arrange to receive duplicate copies of all paperwork and ensure you have complete online access to the account so you can stay on top of your child’s record of repayment.

In short, treat the situation with the same diligence that you would if you were borrowing money yourself. Do what you can to ensure your potential act of generosity doesn’t impair your ability to obtain credit in the future.

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Michael W. K. Yee, CFP®, CFS®, CLTC, CRPC ®, is a Private Wealth Advisor, Certified Financial Planner ™ practitioner, with Ameriprise Financial Services, LLC in Honolulu, HI. He specializes in fee-based financial planning and asset management strategies and has been in practice for 40 years. Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial  institution, and involve investment risks including possible loss of principal and fluctuation in value. Investment advisory products and services are made available through Ameriprise Financial Services, LLC, a registered investment adviser. Ameriprise Financial Services, LLC. Member FINRA and SIPC.
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