Bluestocking
Last week, a friend of mine shared a story of how a mortgage loan is tearing her family apart. A few years ago, her mother co-signed a mortgage for my friend's sister and brother-in-law. They were unable to qualify for the mortgage on their own and her mother wanted to help them, and their two young children, get into the new house.
But my friend's sister and her husband strained to make ends meet. They took out a second mortgage. Unable to continue making mortgage payments, they defaulted on the loan and the bank plans to foreclose. Given the value of the house relative to the debt outstanding, my friend's mother is officially on the hook to pay the bank a large sum. However, the sum is beyond her means and she may be facing bankruptcy.
Todd Morin, an Ottawa-based financial planning expert with Investors Group, sees this kind of unfortunate situation often. Clients have confided that their son or daughter refuse to let them see the grandchildren unless they co-sign for a loan. It's an unfair demand to make of a parent, he believes, and always advises his clients to carefully consider their own financial needs first.
When it comes to family, many of us feel a sense of obligation to help out. After all, isn't that what family is for? But it's important to beware the perils of co-signing for a mortgage or any kind of loan.
When you co-sign a loan, you are making a commitment to a financial institution to repay the loan if the other party that signed the contract is unable to do so. If your relative does not meet his or her payments, a court could issue a judgment requiring you to repay the debt in full. This could ruin your credit record as well as your finances. You need to carefully consider the circumstances of the friend or family member who is making the request.
There are a few different circumstances which may require a co-signer, says Jeffrey Schwartz, the executive director of Consolidated Credit Counseling Services of Canada, a non-profit agency that teaches consumers about personal finance.
One scenario typically involves a minor or someone young who has not yet established credit. They need a co-signer to help them get started. The other scenarios are cause for more concern, typically occurring when someone has insufficient credit available for a purchase or has a record of bad credit.
These are red flags, according to Mr. Schwartz. If a bank will not approve a loan based on a person's finances, it is because he or she already has too much debt or has made bad money decisions in the past.
Another situation which may require a co-signer is when a person has insufficient cash flow. This is more of an orange flag, Mr. Schwartz says. While the person's debt-to-income ratio may be too high for the bank, the person may have the potential to earn more in the near term, making it a temporary situation.
Before agreeing to act as a co-signer, Mr. Schwartz recommends that you look carefully at what category the loan falls under. While no one wants to force a relative into the hands of a sub-prime lender, you need to fully understand the situation. "I think anybody going into a relationship like that with family should at least have the conversation before they do it."
While Mr. Schwartz believes that it is a good idea to approach family first when a loan is needed, it is important for relatives to know when to say no. "Make sure you can always handle the amount of obligation you're taking on in a worst case scenario and make sure that the people you're helping recognize the responsibility of what they're doing."
If you are considering co-signing a loan for a relative, the question to ask yourself is whether you can afford to pay the entire loan. To do that, you need a budget to be able to identify exactly where the money will come from. You may also want to stipulate to your relative that your responsibility as a co-signer is short-term in nature and that you expect it to end with the term of the loan.
Just like Mr. Morin, Mr. Schwartz sees many parents and grandparents who helped out the next generation, only to find themselves burdened with debt. As much as you may want to support your loved ones, it's not worth putting your financial security in jeopardy.
As interest rates rise, leading to more mortgage defaults, Mr. Schwartz worries that the story of my friend's mother will become all too common.