If you’re like most, when you hear of a family member or friend having money difficulties, you want to provide help. In some instances, that assistance doesn’t have to come in the form of cash; you can aid someone financially by co-signing with them on a loan.
Unfortunately, this act of goodwill (which allows someone to borrow money that he or she might not have been able to otherwise) has its drawbacks and is something you need to think through and consider carefully. Read on to learn of the hazards.
When a bank requires a borrower to have a co-signer, it’s typically because that person has bad credit or some other financial reason that prevents them from qualifying for a loan. When you co-sign, you’re essentially assuming full responsibility for the loan in the event the primary borrower is unable to pay. This means that if the borrower can’t afford to make payments, you’re on the hook to come up with what’s due each month—regardless of whether or not you’re living in the home, or driving the car that the money may have been borrowed to pay for.
And you’re not just responsible for a month, or even a few months’ worth of payments, either. If the borrower defaults on the loan and never resumes making payments, you could end up paying out the full amount of the loan.
When Co-Signers Don’t Pay
But what if you can’t afford to make the payments for the co-signed loan yourself? If the lender can’t collect from the primary borrower, their next course of action is to come after the co-signer in order to collect. This means the lender could sue you for nonpayment and garnish your wages depending on your individual state laws. When this happens, the collection is reported in both the borrower’s and the co-signer’s credit reports. Needless to say, if you have great credit, the last thing you want reported in your credit report is a collection. A collection can wreak havoc on your credit score. (Not sure where your credit score stands? You can get your free credit score right here at Credit Sesame.)
Even if the borrower does happen to fulfill the full terms of the loan and is able to pay off the the debt, your own financial situation may still be impacted by the borrower’s payment history. If he or she accidentally misses a payment, or pays late, it will be reported to the credit reporting agencies — in both your credit report and the borrower’s —and your credit score will take a hit as if you missed the payment yourself. Consider too, that if you co-signed or applied for a joint credit card account, your score will also take a hit if the borrower over utilizes the card and carries a large balance from month to month.
Additionally, once a loan is open, it’s extremely difficult to remove a co-signer from it without closing the account and having the primary borrower refinance the loan in their name alone. Keep in mind too, that if you’re looking to apply for a loan or sign up for a new credit card, lenders view co-signed loans as your own debt—which could impact whether or not you qualify because the lender may not want to extend even more credit to you.
When you co-sign a loan, you also have to consider what happens in the unfortunate event that the primary borrower loses their job, becomes disabled or unable to work — or worse, the primary borrower dies. It’s not something any of us want to think about but it does happen and we can’t predict what life throws our way. Bottom line? If you’re considering co-signing a loan, make sure you’re comfortable taking on the loan as your own in the event the unexpected happens.