Why You Should Think Twice Before Co-Signing a Loan

With the economy still gasping along, more and more families are running into credit problems. For some, bankruptcy is the only solution. Others try to restructure their debts. And still others try to borrow money from friends or relatives. If you’ve ever been in this situation–either as the borrower or the lender–you won’t want to miss this guest post by Briana Fabbri.

Do you have friends or relatives who are having trouble getting a loan?  Have you considered co-signing a loan for them?

While you may have both good credit and the best intentions, you should carefully consider the ramifications before you agree to co-sign a loan:

  • First and foremost, lenders will treat this loan as if it were made directly to you.  If the borrower fails to make the loan payments in a timely manner, your credit rating could be affected.  The missed payment could be reported to your credit report, and would potentially reduce your credit score. 
  • Additionally, if the borrower fails to make his or her payments, the lender may ask you to make them instead.  According to the Federal Trade Commission, co-signers are asked to make payments 75% of the time when the loans become delinquent.  These payments may include not only principal and interest, but also late fees.  In most states, the lender can come directly to you instead of asking the borrower first.   This may expose you to phone calls from collection agencies or lawsuits.  You could even have your wages garnished.
  • Even if the borrower makes the payments on time, it may impact your ability to get a loan or increase the interest rate that you would pay.  This is because the bank won’t loan you money unless they feel that you can afford to pay both the loan that you co-signed and the loan that you are applying for.
  • Of course, co-signers are usually family members or very good friends.  What would happen if the borrower failed to pay and the lender came to you instead?  How would you feel about your friend or family member?  It’s likely not worth the risk of destroying your relationship with a loved one in order to co-sign the loan.
  • Plus, it’s important to remember that even responsible borrowers could suffer the loss of a job, a serious medical problem, or even death.  In all of these cases, you may be asked to repay the loan.
  • Once you have co-signed a loan, it is very difficult to get out of it.  While a few loans do have release provisions in them, your main options are usually to either refinance the loan under one name or to pay off the loan entirely.  This can be even more complicated if someone else is in possession of the property.

If you want to help out the individual financially, consider other things that you can do.   Offering alternatives is probably the easiest way to politely decline the invitation to co-sign.  Below are just a few suggestions:

  • If you can afford to, consider giving them the money as a gift!   If they can qualify for a smaller loan on their own, perhaps you can give them just enough to reduce the balance.
  • If you have the money but don’t want to give them a gift, lend it to them yourself.   While you can experience some of the same problems as with co-signing the loan, at least you are not putting your credit rating at risk.   It often helps to write a loan agreement, even for a family member.
  • If they can’t get a loan because of bad credit, educate them in ways to improve their credit rating.
  • If the loan is for a house, perhaps you can buy the house and rent it to them.  They can buy it from you at a later date when their financial situation improves and they can qualify for the mortgage.
  • Provide support in helping the individual to get a better paying job.  Share your contacts. Teach them a skill.  Be a reference.

Are you still determined to co-sign on the loan?  If so, the Federal Trade Commission (FTC) website has some good tips on how you can protect yourself.

Briana Fabbri is a personal finance blogger for NetCredit, an online personal loan lender based in Chicago, IL. Briana holds a degree from the University of Chicago and frequently blogs about credit issues and personal loans.

Note: Ms. Fabbri and NetCredit do not provide financial advice.  Please consult with a qualified financial advisor regarding your individual circumstances.

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