Adult financial life often begins when you move out and start paying bills on your own. But for that to happen, a new study indicates, many young adults need their parents' help — or, really, their parents' signatures.
According to an Experian Consumer Services survey, nearly two-thirds of millennials have used a co-signer to rent an apartment, take out student loans or qualify for other types of debt. Three-fourths of millennials said they would ask their parents to co-sign for them in the future. (In the survey, millennials were defined as those ages 18 to 30.)
“I don't have hard and fast data that show co-signing is growing, but certainly it's very prevalent these days,” said Becky Frost, senior manager of consumer education for Experian. This was the first year the study was conducted.
Co-signing is when a parent or individual guarantees a debt on another's behalf. Although the borrower covers the bills, the co-signer is on the hook if the borrower fails to pay. Given what's at stake, most financial planners caution against it.
“Adult children should ask their parents to co-sign only if they absolutely need to, and parents should agree to co-sign only if they absolutely could afford to make the debt payments,” said Som Hanvanich, a financial planner in Kettering, Ohio.
And yet, as the Experian survey and other data show, co-signing is common. Sallie Mae reports that about 90 percent of customers who take out its Smart Option Loan, a type of private student loan, have a co-signer.
And as national vacancy rates for apartments decline and rents rise, the number of renters needing co-signers has grown. Waterton Residential, which manages apartment communities throughout the U.S., said the number of applicants who needed a co-signer to qualify for a lease grew by 30 percent from 2012 to 2013.
Young adults who don't have long credit histories or big salaries may get better loan terms with a co-signer. At Sallie Mae, for example, students who take out a private student loan with a creditworthy co-signer reduce their interest rate, on average, by more than 1.5 percentage points.
For those who do ask a parent to co-sign, proceed with caution:
SET UP A BUDGET. Before you take out the loan, draft a plan of how you will pay the bills.
“The parent and child should create a budget and review how payments will be made,” said Michael Solari, a financial planner in Bedford, N.H. “It's also a good exercise for the child to see if the purchase is worth altering their lifestyle.”
DRAFT A PLAN for when you can't pay. Most young adults who borrow with a co-signer manage their debt well. According to the Experian study, only 8 percent of these accounts were in bad standing because of late or missed payments.
But when trouble does occur, you and your co-signer should have a plan in place for how the problem will be solved.
“Parents should make this plan a condition of co-signing,” said Susan Bryant, vice president of marketing and media sales at Apartments.com.
CONSIDER ALTERNATIVES. Is there a way to get around needing a co-signer? With apartment rentals, for example, a landlord may waive the co-signer requirement if you provide a bigger deposit upfront (which your parents may be willing to help finance, if needed).
“Instead of one month's rent, offer two,” Bryant said.
SET UP AN EXIT STRATEGY. If you do have a co-signer, know the rules about if and when a co-signer can be removed from the loan. Just beware that releasing a co-signer may not be easy.
A recent report by the Consumer Financial Protection Bureau, which analyzed thousands of private student loan complaints and debt collection complaints related to student loans, shows that borrowers often face obstacles when seeking to release a co-signer from a private student loan.
What's more, the report found that if the co-signer dies or files for bankruptcy, you could suddenly owe the remaining balance of your student loan in full — or have your loan placed into default. For more information, go to ConsumerFinance.gov.