Have you ever been approached by a friend or family member asking you to cosign on a loan for them? They will most likely promise you that they are good for the monthly payments and just need some help getting approved for the loan. You want to help them out, but is this a smart thing to do? What are the risks to you as a cosigner? These are important questions to ask yourself before you commit to cosigning on a loan.
What's the big deal?
A lender requires a cosigner when they are not confident a borrower can meet the obligations of the loan. This should be your first warning sign – if a professional lender isn’t sold on the borrower, why would you be?
As a cosigner, you are committing to the lender that you will make all payments on the debt if the primary borrower does not. You become 100% responsible for the debt. If the primary borrower stops making payments, you are expected to make payments on-time to the lender – including any late fees and penalties.
You take on all the risk, without any of the benefits since you have no ownership rights to the property being purchased.
Know the Risks
Helping someone get a loan is a generous thing to do, but it is important to understand the risks before signing on the dotted line.
- Damage to your credit score: Anytime you’re a co-signor on a loan, it is detrimental to your credit score to a certain degree. If the person you co-signed for is late with a payment, your credit will also take the hit. This could mean you won’t qualify for loans you need to take out in the future.
- Can you afford the payments? You are agreeing to make payments on the loan, so the lender will come to you if the borrower isn’t making the payments. It doesn’t matter why the borrower is missing payments, you should be prepared to step in and start making payments if need be. Setting some money aside in a savings account is a smart step to make sure you have the money if need be.
- Legal judgments could lead to garnishments: If you do not make payments, you may be hit with legal action (after all the fun of collection letters and phone calls). These could even go as far as wage garnishments or funds pulled from your bank account if you don’t pay.
- Your ability to borrow may be compromised: Cosigned loans appear on your credit report, so even if the borrower is making the payments, lenders will view the loan as your obligation. This reduces your monthly cash flow in the lender’s eyes, so it can make it harder to qualify for a car loan or mortgage.
Beyond the Money
In addition to the possible damage to your finances, cosigning agreements that go bad can damage personal relationships. I have seen people cosign for kids, boyfriend/girlfriends, friends, and spouses, but when someone leaves you with their debt and mess, feelings get hurt and relationships damaged.
Making sure you understand the risks of cosigning can spare you some major headaches down the road. Wanting to help people out is a good thing, but cosigning a loan for someone may not be the best option to provide that help.