Things to Know Before Co-Signing A Loan
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If you are working and have good credit, you may get a request to co-sign a loan. Your kids need cars. Your parents want to fix up the fixer-upper they bought. Your brother wants to go back to college and get his life together. You aren't obligated to say yes, but of course you'd like to help out. But before you sign on the dotted line, understand the risks.
Advantages to Co-Signing
It isn't easy to get a loan these days, so if a friend or family member needs money, you want to be there for them. Maybe somebody co-signed for you when you bought your first house or helped you through school. And heaven knows, you'd like to believe that your own kids, parents, siblings and friends are trustworthy. If the person whose loan you co-sign pays off what he owes, you're off the hook, and it's a happy ending — but it isn't the only ending.
Disadvantages to Co-Signing
The disadvantages of co-signing a loan come to the forefront if and when the borrower doesn't pay it back. You may have faith that the person will be reliable and responsible, but that shouldn't mean you ignore the risks. Don't forget that the reason the lender is asking for a co-signer is because the borrower's credit record indicates that he may not repay the money. The lender's risk becomes your risk when you co-sign a loan.
Your Credit Is Impacted
When you agree to co-sign a loan, you put your own credit as well as your relationship with the borrower on the line. If the borrower makes payments late, your credit score is affected negatively. If the borrower misses a payment altogether, your credit score takes a hit. If you’ve ever seen the borrower spending money on frivolous purchases, you will be watching them with very different eyes once you co-sign his loan, wondering whether he has made the payment that month.
When the Worst Happens
If the worst-case scenario occurs, and the borrower defaults, you're on the hook for the loan. The legal consequences are the same whether the borrower defaults because he comes down with a debilitating illness or because he spends his money irresponsibly. You will be legally obligated to make the payments for his truck, house renovation or college tuition loan. To add insult to injury, your credit report will contain all of the sins of the borrower, to the same degree as if you had committed them yourself.
If You Go Ahead
If you decide to go ahead and co-sign a loan for someone, being proactive can help make it is a good experience. Arrange for email alerts to remind you when payments are due, late or posted. Ask the lender to advise you just before a default so you can protect your credit. Another good idea is to have the borrower set up a "safety net" account with several months of payments in it and arrange for the lender to debit that account each month.