Why co Signing a Loan is Risky Business

When co-signing or endorsing a loan you are telling the lender that if the primary borrower defaults (fails to make regular scheduled payments) on the loan you (the co-signer) will make those payments to keep the loan current and in good standing. This can be very “risky business”. Co-signing for a loan can have serious consequences such as loss of friendships, damaged family relationships and future credit problems. 

One of the first questions you should ask yourself before deciding whether to co-sign on a loan is why are you needed to co-sign on the loan? Is it because the primary borrower has a derogatory credit file (bad credit), does not have enough provable income to support the payment, short length of employment (employment for less than two years), limited credit experience ( primary borrower has credit, but not enough to determine how the account will be handled), etc. Once the reason is determined you can make an informed decision as to whether or not you should co-sign on this loan or not.

The second question is can you afford to make this payment if for some reason the primary borrower is unable or unwilling to continue to make the regularly scheduled payments. In the event the primary borrower defaults the responsibility to repay the loan now falls on you. If the payment is not made by either the borrower or the co-signer it will have a negative impact on both borrowers credit file. For example a late payment will show on a borrower’s credit report for seven years from the date of the occurrence. A charged off loan or repossession can report for up to 10 years.  

Co-signing for a loan could stop you from obtaining future credit. When you co-sign on a loan it is reported on your credit bureau. So now whenever you apply for credit the payment amount of the loan is added to your debt to income ratio or dti. Most lenders do not like to lend money to borrowers with high dti. This is primarily due to a greater risk of default by the borrower.

Make sure to read the fine print. Whenever you co-sign for a loan you will be asked to sign what most lenders refer to as a loanliner agreement (an agreement to repay the loan). In it are the terms for borrowing and repaying the loan. What most co-signers do not know is that most loanliner’s have a clause that states if for some reason the primary borrower defaults and a payment is not made the lender can take money from any account in which the primary borrower or joint borrower are on. For example let’s say you co-sign on a car loan for your son or daughter. 18 months into the loan your son or daughter default on the loan. You decide it’s their loan and their responsibility to repay it not yours. The lender can take money from an account you have with them (the lender) to pay the loan payment that is due. For instance you have a joint account with your wife. Money can be pulled from that account to make the loan payment you co-signed on with out your permission by the financial institution.  

If you decide to co-sign on a loan for someone, make sure that the person handles the account responsibly. If the primary borrower shows good repayment during the first year most lenders will allow them to refinance the loan in only their name. This will remove your name from the loan and eliminates your responsibility to repay the loan in case of default.