There are many situations where you might find yourself being asked to co-sign a loan. Often such a request can arise in the context of a personal relationship. For example one of your children may ask you to co-sign a loan for a first car or for college tuition, or a friend or relative in financial difficulty may turn to you for help.
There are actually a few potentially positive benefits to co-signing a loan. If the loan is paid off in full and on time, then that record of repayment becomes a positive mark on your credit score. You also have the personal satisfaction of having helped a family member or friend to obtain money they needed but could not have obtained without your help. The transaction can also give you insights into how certain loans work and establish contacts with people in the lending community that you might otherwise have never met. Such information and contacts can be useful to you in the future.
However, despite these benefits co-signing a loan is something that most people approach with at least some hesitation, and with good reason. Being the co-signer of a loan means that you will have to assume important responsibilities in the event something goes wrong and the person you co-signed with is unable to keep up the payments. Under those circumstances you can be forced to assume responsibility for making the missed payments or even for paying off the loan in full, even if you personally never saw one cent of the money that was borrowed.
The situation can become even worse if you are not in a position to assume the payments. In that case the loan may go into default and you will find your credit score being damaged just as badly as the person you co-signed for. Therefore a co-signed loan that goes bad can leave you in debt for money you never received and your personal credit histoy damaged. Also, the amount you owe can be increased by penalties and collection fees, further crippling your financial health. You may also lose some of your own possessions if the lender goes to court and you are forced to sell your personal property to pay off the loan.
In other words, a co-signed loan that goes bad can become a financial nightmare. That is why you should always exercise extreme caution before agreeing to co-sign a loan for anyone. It is best to assume in advance that the loan may have to paid by you, and thereby consider the means by which you would repay it and whether the resulting financial situation is acceptable. Never co-sign for a loan with someone else that you can’t afford to pay off entirely yourself if circumstances require.
Of course it goes without saying that you would not co-sign a loan with someone who is not responsible or doesn’t have a reliable income. However, always remember that even the best intentioned people can have accidents, illnesses, and unexpected job losses that can suddenly put their ability to repay the loan in jeopardy. Therefore it is best to take certain precautionary measures in advance of co-signing a loan such as getting everything in writing.
Whatever personal arrangement you make with the person you are co-signing with should never be just verbal. You should get everything in writing, even though doing so may seem awkward when you are dealing with family or friends. Yet having a legally binding side document establishing everyone’s responsibilities in case of a default can actually help preserve a close relationship by clarifying in advance what will happen. Many personal relationships have been ruined by bad loans, but a binding agreement that anticipates in advance the aftermath of a default will actually help to minimize hard feelings in the long run.
That is why it is often a good idea to hire a lawyer to draw up an agreement clearly identifying the roles and responsibilities involved in any co-signed loan. Ideally everything will turn out fine and the agreement will never have to be enforced. But if the worst occurs, then you will be glad to have all the rights, responsibilities and obligations of both parties clearly spelled out.
Author: KC Beavers
KC Beavers is a semi-retired entrepreneur. The subject of personal finance has always fascinated him. In an effort to not bore those around him with all his love of personal finance as much he has come here to bore all of you instead.