It is an all-too-familiar story: You co-signed a loan for a relative, friend, or a friend of a friend, just to end up having your own credit ruined by someone else’s bad money management. You might believe that you are doing a good deed by helping someone else get a car or try to save a failing business, but it could come back to haunt you.
Sympathizing and wanting to help is understandable — but co-signing is not always the best option.
Co-signing Makes You Responsible
Lenders request co-signers because they consider the borrower to be a risky bet. If the borrower were credible, there would be no need for a co-signer.
Lenders ask for a creditworthy person (you) to take responsibility so that lenders have someone else to go to when they don’t get their money. Basically, when the borrower stops making payments, you are their backup plan.
Co-signing Puts Your Credit At Risk
According to some personal finance experts, the golden rule of co-signing is, “don’t cosign anything.”
Without the cash in the picture, putting down your Social Security number and signature seems harmless. But you are essentially borrowing money and giving it to someone else.
The common advice is that you should only co-sign a loan you are willing to pay off, regardless of whether the borrower contributes to repayment.
Would you give the borrower $10,000 in cash right now? If that sounds like something you would never do, you probably don’t want to cosign that $10,000 loan.
In fact, co-signing a loan could be worse than giving money away. If the borrower defaults, your credit score would take a nosedive and you could also lose any property used to secure the loan. At least by handing over cash, your credit would remain safe. And don’t forget the bundles of fees and late charges that you wouldn’t have to deal with.
Co-signing loans has become such a problem that even the Federal Trade Commission (FTC) addresses the issue on its website here.