A few weeks ago, I read an article entitled "Should You Cosign With Your Kids" on CNNFN. As an estate planning attorney / tax attorney in Utah, asset protection is almost always part of my client engagements. As I help clients develop asset protection plans (using basic estate planning tools to complex trusts and family limited partnerships), debts on which they have cosigned with their kids are frequently discussed. I am frequently surprised to find out that some of my clients have not given any thought to the consequence of cosigning on a debt with a child. To be clear, when you cosign on a debt with your child, it is because his or her credit is not sufficient to secure the loan. For many clients, it seems that lenders put the child on as a courtesy, but the parent is always the primary debtor. That means that if the child made a bad investment or defaults on the debt, the parent is stuck paying the bill--i.e., the parent's assets are exposed.
I have seen this situation come up a lot in the past few years as parents have cosigned with children to help them make real estate investments. Of late, I have had several clients who have signed guaranties for children or who have cosigned with children have to pay large settlements, eating away at their retirement savings. A commonality with most of these clients is that they did not understand what they were doing when they cosigned.
The article I referenced above seems to focus on smaller matters (e.g., cosigning on a credit card, apartment lease, car), but it raises several precautions, as follows:
1. Consider what your child would do with the amount of money he/she is borrowing. For example, if you are cosigning on a credit card with a $10,000 limit, consider whether your child could responsibly manage $10,000.
2. Pretend you are the lender. Investigate your child's credit. No one wants to know the dirt about their own children, but to save your retirement...I'd suggest it is worth it.
3. Understand the risks. If you cosign, you are almost certainly the primary debtor (not a secondary debtor, as I have suggested above).
4. Limit your exposure. Don't cosign for more than is absolutly necessary for the child. Go for a small credit limit on a credit card.
To these points, I would add that if you have cosigned on a debt, you may want to adjust your will and/or revocable living trust to adjust that child's share. Otherwise, the debt may be settled as part of your estate and paid from your assets even though the child has benefitted, not your estate. This is frequently the case. You can adjust your will or revocable trust to adjust shares distributed to your children. I recommend you do this with an estate planning attorney to assure smooth estate (probate) and trust administration.
If you have loaned money to a child or cosigned with a child, make sure it is addressed in your estate plan to avoid future family contention.