When you co-sign on a loan, you become legally responsible for the person’s debt if they don’t pay it. That’s good news if you know the person can pay you back.
Co-signing can help a friend or family member get authorized for a loan that they would not have been able to receive otherwise. However, guaranteeing a loan for someone else is problematic.
Understand what occurs when you co-sign a loan and the risks it can pose to your financial stability.
WHAT TO EXPECT WHEN YOU CO-SIGN ON A LOAN:
A co-signer assists a borrower by adding their name to the application. Typically, co-signers have sufficient income and credit scores to enhance the loan application.
Lenders may choose to approve an application when a co-signer is available. Co-signing is separate from being a co-applicant who is not requesting to use any of the loan funds.
Instead, they promise to repay the debt if the borrower stops paying payments or defaults altogether. Besides being liable for the loan’s repayment if the borrower is unable or unwilling to do so, a co-signer may also be responsible for the following:
- Late fees
- Collection fees
THE DANGERS OF CO-SIGNING:
There is no harm in wanting to help a family member or close friend who is in need. However, there are risks when volunteering to co-sign on a loan.
So, before you decide to save the day, be aware of some of the dangers.
- Total liability – If the borrower cannot pay the loan, the lender collects from the co-signer.
- Limited ability to borrow – Co-signing limits the amount of monthly income available for new loan payments. In addition, being a co-signer can hinder you from obtaining other loans, such as a mortgage or a car loan.
- Absence of ownership – When you co-sign for a loan, you assume all the risks but no rewards. You don’t own the asset the borrower buys because you helped them get it.
- You are bound to the loan – It is possible to get out of a debt (or get a co-signer out), but it is a complicated process. You will likely remain a co-signer until the end of the loan.
- Negative impact on your credit report – If the borrower can’t afford to pay the loan and you can’t either, the loan will go into default and decrease your credit score.
WHEN IT IS SAFE TO CO-SIGN FOR A LOAN:
Only agree to co-sign for another person’s loan if you can afford to take over the payment. If you have enough extra cash flow, you should be able to pay off the loan if your borrower defaults.
You will still need to demonstrate that you have the necessary income and assets to qualify for any personal borrowing. Bear in mind that while you may be able to afford the risk now, you must also be prepared to withstand losses in the future.
THE BOTTOM LINE:
If you have good credit, make a decent amount of money, and you have family and friends that know it; eventually, someone will come to you with a need for a co-signer.
And while you may have the heart to help, make sure you have the money should you have to assume the loan payment.