Should You Cosign on a Loan for Your Child?

Guest post by Janet Hutchins. Janet writes for Credit, Eh, a blog about smart personal finance and responsible credit card use.

It’s only natural for parents to want to help their children. One way that many parents help their children is to cosign on a loan. When you cosign for a child who may not be able to get a credit card (the CARD Act makes it harder for those under 21) or a car loan because they don’t have established credit, you are providing a way for your child to establish credit while at the same time helping him or her get something needed.

Before you cosign, though, it’s important to understand the realities associated with putting yourself – and your good financial reputation – at risk. Cosigning for anyone, even for a child, is a decision that requires a great deal of thought.

How Responsible is Your Child?
Your first concern should be to honestly assess how responsible your child is. Before you help your child borrow any money for any reason, evaluate his or her level of responsibility. This goes beyond just responsibility in money matters, although that is of primary importance. Some things to consider include:

•    How does he or she manage money? Look at the money habits followed by your child. Does he or she keep within his or her means? If your child is always asking to borrow money from you, this is a sign that he or she is not ready for a loan. However, if your child sets money aside for the future, and is judicious about spending, it could be an indication that he or she could handle a loan payment.
•    Does your child demonstrate accountability? Observe whether or not your child is willing to take responsibility for his or her actions. Does your child make it a point to own up to mistakes and fix them? Does your child get homework and chores done without making excuses all the time? If your child is accountable for his or her actions, it is likely that he or she will show the same level of accountability when dealing with credit situations.
•    Has your child shown responsibility and a sense of priorities in other areas of life? You don’t want to cosign on a loan for someone who doesn’t understand priorities, and who doesn’t behave responsibly. This includes showing up on time for work, getting homework and chores done before seeking entertainment, and ensuring that bills are paid before the “fun” stuff is bought. If your child demonstrates the ability to understand what’s important, and what should be finished first, he or she is likely to be ready for credit.

If you cosign on a loan for an irresponsible child who isn’t ready to take on the debt, the consequences to your own finances could be very real and lasting.

Are You Ready for the Consequences of Cosigning?
Realize that there are very real consequences associated with cosigning on a loan. When you cosign, you put your own money up to cover the loan if the borrower defaults. If you don’t trust your child to make payments, don’t cosign because it’s your money – and your credit rating – on the line.

Also realize that the loan will show up on your credit report. This means that if you are planning to borrow money soon, and you are afraid that cosigning will make it appear as though you can’t handle the extra debt, you should avoid it.

Carefully consider the consequences of cosigning for your child. Make sure you are comfortable with your child’s ability and willingness to fulfill the loan terms, and double check to ensure that you are in a financial position to handle the obligation.