The Dangers of Co-Signing a Loan

Debbie Dragon

By , Staff Writer
Posted on Thu Jan 31, 2013, Last Updated on Thu Jun 12, 2014

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When a person needs a co-signer, it is generally because the lender feels that the borrower does not have the means to repay the loan on their own. If you decide to co-sign a loan for a friend or family member, you are just as responsible for the money borrowed as the other person – which means if your friend or family member fails to make a payment – the lender will look to you for the money.

Legally, there is no difference between the applicant and the co-signer when it comes to the responsibility for making payments on the loan. If the loan payments aren’t made, the co-signer can be sued, credit rating ruined, your wages can be garnished and, in extreme cases, you can even lose your house. Co-signing a loan is extremely risky.

The risks of co-signing

It can be hard to say no when a family member or a close friend requests your help in getting a loan – especially if they’re planning to use the money to improve their situation.

Money issues are the quickest way to dissolve a relationship with a friend or family member, so if there is any chance at all that the person you are considering co-signing for will be unable to make their payments, you may want to tell them you are unable to co-sign.

If you are considering co-signing, make sure you truly understand the risks:

  • Your credit report will be reviewed by the lender, and it counts as an inquiry which will temporarily lower your credit score.
  • Your credit score will be affected if the borrower doesn’t make payments on time.
  • You will have to pay the loan back if the borrower fails to pay it and if you don’t, you will face the same consequences that not paying your own loans would cause.
  • Your credit score will also be affected because your debt to available credit ratio will be affected by the amount of the loan you co-sign for.
  • Lenders do not always call or send a notice to co-signers that a payment has been missed – don’t be surprised if you start receiving phone calls from debt collectors.
  • If co-signing for a car loan, keep in mind the friend or family member’s name is on the car’s title – which means you can’t even take the car from him or her if you end up having to make the payments. If they stop paying the loan, the debt becomes your responsibility but the car belongs to the person’s name on the title.
  • Student loans have a tendency of growing – so if you co-sign for a $25,000 loan and the student capitalizes the interest during the first year or two of the loan, the loan amount can grow as much as 33% – making you responsible for $33,000 even though that wasn’t the amount in the original agreement.

Co-sign with caution

If you understand the risks of co-signing and still decide to proceed with helping your friend or family member get the loan, here are some tips for reducing your risks and improving the process:

  • Consider having the statements sent to your address and requiring the friend or family member sends the payments to you, too. This allows you to keep track of the due dates and ensure the loan is being paid on time.
  • Only co-sign for a loan amount that you could pay off without financial difficulty if the friend or family member bails on the loan.

Help without co-signing

If you want to help a friend or family member but feel the risks for co-signing a loan are too great, there are other ways you could help them financially. You might consider loaning them money from your savings and setting up a payment plan between you. This will not eliminate relationship issues that occur when the borrower doesn’t make payment as planned, but it saves you from having to make payments on a loan to a creditor or risking having your credit score ruined.

 

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