Walk Away From Co-Signed Loan? No Such Thing

Dear To Her Credit,

I co-signed on a home equity line of credit for my mom. Fast forward a few years, her home has been foreclosed on and the home equity line of credit has a balance of over $22,000. My mom is in a nursing home due to four strokes, she does not have a way to pay off this loan. I have approached the holder of the loan to consider a settlement. Their initial offer is $7,500 but they would need to confirm my financial information before finalizing an amount. I don't know that they would settle for the $7,500 after they consider my income. My salary is about $130,000.

I am a single mom, with three teenage children and a mortgage (and receiving no child support). My biggest concern about my credit score is being able to secure loans for the kids' college. Since settling debt negatively affects your credit score anyway, should I settle or just walk away? Thanks.

- Sherrie

Dear Sherrie,

You co-signed with your mom, and you got stuck with the bill. Now you want to resolve that debt, apparently so you'll qualify to co-sign with your kids on their student loans.

Ten or 15 years from now, when one of your kids can't pay his or her student loans, you'll be stuck with them and wondering how to get out of that mess. And yes, those loans will really be yours, just like your co-signed loan with your mom is really yours.

There's only one solution: Stop co-signing. You're a good daughter and mom without taking on other people's debts. That's the most important thing I can tell you and anyone else considering co-signing on a loan. It's hard to say "no" to a parent or a child. It's even harder to imagine that they will leave you holding the bag. Nevertheless, it happens -- all the time.

Now that your mom is unable to pay, the debt is just as much yours as if you had taken out the loan yourself. If you can pay it in full, you should, just the same as you would pay any of your other debts.

It's hard to say if the bank will let you pay a reduced amount after it considers your financial situation. If it does, the settled debt will affect your credit score. If you need to rely on your credit history in the near future, for example if you apply for a mortgage, the damage to your score could cost you more than you save by settling the debt.

You say you're wondering if you should settle or just "walk away." If by walking away you mean just ignoring the debt and hoping it goes away, I can't recommend that under any circumstances. You don't really have any place to walk away to, at least not where the bank cannot come and find you. You have a good income and probably a house and other assets. The bank can take you to court and attach your assets if you ignore the debt long enough. By that time, you won't owe just $22,000. With late fees and interest, your balance could double or triple. You'll receive phone calls and letters, and the stress will take its toll on your health and happiness. "Walking away" is not the easy way out. It's the hard way, by the time you deal with the consequences of doing so.

When it comes to your credit score, never just assume, "Well, it's damaged anyway, so I might as well let it be damaged further." There are degrees of harm to your score, and even 20 points this way or that can make a difference next time you need to rely on your good credit.

As far as your kids' student loans go, the effect your credit score has on them depends on the type of loan for which they apply. If your kids apply for Stafford loans, the popular government-backed loans for students, your credit score will have nothing to do with whether they get the loan. The loans are in the kids' names, not yours, so the lenders won't even look at your credit report.

If you apply for a Parent Loan for Undergraduate Students, or PLUS, you may get a loan without perfect credit. The standards are not as stringent as with some loans, because student loans are rarely forgiven in bankruptcy. However, when you apply if you are in default on a loan or have "adverse credit," as would be true if you walked away on your mom's loan, you won't get a PLUS.

Private loans are definitely affected by your credit history and score. But as with the other loans, your credit history only affects loans for which you apply. It doesn't affect your kids' ability to secure loans themselves.

Scratch "walking away" off your list of options. Your only realistic choices are to pay the account in full or to settle with the bank. If you can afford the payments, you should keep them up until the balance is paid. Otherwise, settle with the bank and then start rebuilding your credit as quickly as possible.

Remember, the original borrowers looked for a co-signer because they couldn't get a loan by themselves. From now on, never co-sign on a loan that you are not ready, willing and able to pay on your own.