In a few weeks, many college students will be going back to campus again, or for the first time. But with college being as expensive as it is these days, the majority will rely on student loans to help them cover all of the costs they might incur, and in some cases, their parents may choose to co-sign on that financing as a means of helping the kids out.
However, it's important for parents to keep in mind exactly what they're getting themselves into when they sign onto this type of contract, as it may have massive implications for their credit when those bills come due. The problem with student loans specifically is that parents might agree to co-sign on them with their kids and then more or less forget about them, because they will not come due until after the young adult graduates. This can also be a problem if parents agree to sign on for their kids' credit cards as well.
What does this mean?
In both cases, the credit implications can be massive. What you may not realize is that when you're co-signing on credit, you're agreeing to be jointly responsible for every penny of the debt incurred, and as such it will be closely tied to your standing for as long as the account is open. Essentially, when you co-sign on an account with anyone — a family member, your children, your spouse, etc. — any changes to the account will affect you both equally, and fully. There seems to be a common misconception that if you co-sign, you are each responsible for 50 percent of an account, or in some cases less; some people may even think that their co-signing responsibilities end when the other person takes control of the account as long as they are the only ones using it.
This isn't true, though. Say you co-sign on a credit card for your child to help them have a little spending money while they are in college, that will affect what is known as your "credit utilization ratio," which is used to determine 30 percent of your credit score all by itself, right away. The amount you owe is viewed as a percentage of your total credit limits, and at first, taking on the new card will raise your limits without boosting your balances. Of course, as the card is used and debt potentially begins to pile up, you might end up using an even greater portion of your limits than you were using before.
Here's an example: Suppose you currently owe $3,000 on credit limits of $10,000 spread across four cards, putting you at the 30 percent threshold at which your score starts to deteriorate for having too much debt. If you add another card with a $2,000 limit and another $1,000 in debt is added to it by your child, that brings the total you owe to $4,000 on $12,000, or a 33 percent usage rate, which will certainly start to bring your score down.
Likewise, if that student misses a deadline on the credit card bill or, down the road, their student loans, that will also reflect poorly on you, which would be bad news because payment history makes up another 35 percent of your score.
What should you do?
Instead of co-signing on accounts, it might be important to think about the impact such a decision would have on all aspects of your finances going forward. You may still be willing to do so after you've had a lengthy discussion with your child about the best ways to manage finances and make sure all payments are sent in on time and in full, but caution is still very key at this time. After all, this is a person who has likely never had any kind of financial responsibility of this kind before, and as such they may be prone to a few mistakes, just as you likely were at their age. Taking all options and potential outcomes into consideration is likely a wise choice before any final moves.
In addition, you might want to stress to your kids the importance of checking their credit reports regularly. If any unfair markings are discovered, they could benefit from contacting a credit repair law firm, whose assistance may help them remediate the issue.