Dear Penny: Can I Avoid Default Risk if I Co-Sign My Daughter’s Mortgage?

A mother and daughter talk in the kitchen.
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Dear Penny,

We have a 47-year-old daughter with a just-settled divorce. She is a teacher, but she’s not working full time. She is asking her parents to co-sign for a home purchase.

We are retired and have a paid-for home. What financial tool could we use to protect ourselves from default possibilities?

-J.

Dear J.,

You can’t be a co-signer without putting your finances at risk. From a bank’s perspective, that would defeat the point of co-signing.

When someone doesn’t qualify for a loan or credit on their own, the lender can sometimes approve their application if they find a co-signer. If you’re deemed an acceptable co-signer, it means you have a strong credit history. The lender has essentially determined that you’re not willing to put that pristine credit at risk, so you’d be willing to step in and make payments before you’d let that loan go into default.

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If you co-signed a mortgage for your daughter and she then defaulted, the consequences would be the same as if you were the original borrower. The default would stay on your credit report for seven years. You’d have difficulty obtaining credit for yourself, particularly in the first couple of years after the default. Even if your daughter makes on-time payments, you’re still increasing your debt-to-income ratio since you’re legally on the hook for the mortgage.

It’s admirable that you want to help your daughter through a tough time. But unless you’d be able to make mortgage payments for her, I’d urge you not to co-sign. My advice for co-signers is to hope for the best but assume the worst, i.e., that you’ll be the one making payments.

Remember: Banks make money by lending. When they’re not willing to approve a loan without a co-signer, they’re passing on potential profits because the risk is too great.

Consider whether there are other ways to help your daughter financially without signing off on such a huge debt. Could you allow her to move in with you to rebuild her savings? If she has black marks on her credit report, the damage will begin to heal within about two years. Plus, if she’s able to eventually resume full-time work, she’ll probably have an easier time getting a mortgage.

Or could you help her with the costs of renting an apartment? Should she need a co-signer to rent, I’d be less opposed to you putting your name on a lease than a mortgage. Your liability would most likely be capped at a year’s worth of rent versus 15 to 30 years of mortgage payments.

You could also help your daughter by giving her cash for a down payment if you and your spouse have decent savings. A substantial down payment reduces the risk to the lender, making it easier to approve a borrower with shaky finances.

If you’re determined to co-sign for your daughter, though, it’s essential to have open lines of communication. Set a hard limit on the loan amount you’re willing to co-sign for. Make sure your daughter is aware that you’re putting your own credit and assets at risk by taking on responsibility for her home loan.

Most importantly, be clear on what your daughter should do if she’s unable to make payments. If she knows she can’t afford a payment, she needs to let you know ASAP. You don’t want to find out that she’s struggling after she’s already missed payments.

For extra reassurance, you could require that you have access to your daughter’s account with her lender. That way, you can verify at any time that she’s made payments as agreed. You could also ask the lender to send you alerts whenever a payment is made to make it easier to keep track.

Also find out what the lender’s policy is for releasing you as a co-signer. Sometimes it’s possible to remove your name from a loan after a certain number of timely payments, particularly if the original borrower’s income increases and their credit score improves. But lenders are often extremely hesitant to do so because it increases their risk. To get your name off the mortgage, your daughter may need to refinance it in her name alone.

If you’re not willing to take on the risk of co-signing, be honest with your daughter. This isn’t about your love for her or your willingness to help her out. It’s also not a moral judgment for whatever financial situation she’s in. Once you’re retired, you have to be extra cautious about taking on more liabilities, since you’re typically on a fixed income.

Your daughter is no doubt trying to move on from a difficult chapter of her life. Of course, you want to give her love and support. But unless you’re OK with making her mortgage payments, you simply can’t afford to show your support by co-signing.

Once you finally get your finances in order, you want to keep them that way. Here are several moves to make now.

Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. Send your tricky money questions to [email protected].