Should You Co-Sign a Loan?

Should You Co-Sign a Loan?

403b loan

Let’s say you are approached by a friend or relative asking you to co-sign a loan. Obviously, they assume that they will make good on their loan, pay it in full, and you will never have to worry about it. Being the nice person that you are, you are likely to oblige. But wait! Before playing the nice guy, you should really sit down and think about what it is you’re actually agreeing to.

What Are the Chances the Borrower Will Default and Leave Me Holding the Bag?

According to the FTC, most lenders revealed that of all the co-signed loans that go to default, as many as three out of four co-signers are required to repay the loan. Now those aren’t good odds if you’re the co-signer.

Remember, your friend or relative has asked you to co-sign because he or she has been turned down for credit by a lender and can’t borrow the money on their own. If they raise a red flag with lenders, it should at least raise your suspicious as well. Granted, sometimes this is due to a lack of credit history rather than bad credit, but the reality is that a lender, who is in the business of lending money, felt that the borrower is too much of a risk. This should give you pause for thought.

What Will Happen If the Borrower I Co-signed for Misses a Payment?

In most states, if the borrower misses a payment, the lender can come after you first, without trying to collect from the borrower.

  • You could be required to pay late fees or attorney fees.
  • You could have your wages garnished.
  • You could lose any property you pledged against the loan.
  • You could be sued.

What Should I Consider Before Co-signing a Loan?

Before you co-sign for a loan, be sure you can afford to pay the debt if the borrower defaults on the loan. You may feel confident that this won’t happen, but consider the unexpected: people lose their jobs, become ill or disabled, or die unexpectedly. Others are just irresponsible. When you co-sign a loan, be sure you are capable of repaying the loan, and that it wouldn’t cause a financial hardship or jeopardize your own credit. But if you’re in a situation where having to pay this loan yourself would put you into a financial hardship, resist the urge to co-sign even if it means helping a close friend or family member.

Will the Co-signed Loan Affect My Credit Score?

Yes, it will. The loan you co-sign will show up as a liability on your credit record, which may prevent you from obtaining credit yourself. If you’re planning to buy a house, car, or other large purchase during the life of the co-signed loan, you may want to think twice. Keep in mind this is different than being an authorized signer on an account. Those typically don’t show up on your credit score, but when you co-sign, you’re pledging your credit.

Is It Ever a Good Idea to Co-sign a Loan?

Despite the risks, there are times when it makes sense to co-sign a loan. For instance, many parents do it for their kids to help them establish credit. This is especially true that these days with new credit card rules in effect it’s harder for young adults to obtain credit. Obviously, parents co-signing for children is a bit different than if you were to simply co-sign for a friend who is in a financial bind.

Is There Anything I Can Do to Protect Myself If I Do Co-sign a Loan?

If you do decide to co-sign a loan, try to get the lender to agree in writing that in the event of a default, you would be responsible for only the principal balance of the loan. This would protect you against legal fees if the lender decided to sue.

Also ask the lender to agree in writing to notify you if the borrower is late with a payment. This could give you valuable time to try to rectify the situation before it gets out of hand. And make sure you get copies of all the paperwork for the loan. If the lender won’t give them to you, get them from the borrower. Finally, before you make the decision to co-sign a loan, you should know the purpose of the loan, type of loan, and terms of the loan. Make sure you read all of the fine print as if you were getting the loan yourself.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

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