Should You Co-Sign a Loan? And 4 Reasons Not To

It’s one of the most awkward conversations in modern life. A friend or relative asks you to co-sign a loan for a new car or a house — with the promise that of course they’re good for the money, it’s just a problem getting a bank to lend to them. The friend tells you what a bind they are in (for what ever numerous reasons) and how badly they need the money.

Co-Sign-Loan

The Risks of Co-Signing a Loan

You want to help, but isn’t co-signing risky? You bet it is. If you’re in the position to help a friend or family member by co-signing a loan, here are the dangers you should know before you sign on the dotted line:

1. A Professional Said “No”

Your friend is coming to you because a professional lender is not willing to do what she’s asking you to do — guarantee that this debt will be paid. Know that your good credit and financial history is what provides the lender security. So if you don’t have the amount of the loan liquid, you may find yourself losing assets in order to pay off the loan if the primary borrower defaults.

2. You Become Liable for the Full Payment

It’s a common misconception that lenders will go after the primary borrower first to collect the debt in case of missed payments or default. However, many loan agreements state that the lender can pursue the money from whomever it chooses, which typically means it will go after whatever is the most likely avenue for payment. That often means the co-signer. (There are some states that require lenders to first try collecting from the primary borrower before collecting from the co-signer.)

3. You Can Owe All the Fees

Should the primary borrower default on the loan, co-signers will often find themselves responsible for late fees, collection fees and possibly even legal fees in addition to the amount of the loan plus interest.

4. Your Credit Rating Can Be Affected

Co-signing a loan can negatively affect your credit rating. If the worst happens and the debt goes into default, that could become a part of your credit record. Even if your friend or relative is diligent about making payments, the loan could still harm your credit. The loan would be considered part of your financial obligation and be factored into your debt-to-income ratio should you attempt to get a loan for yourself before the debt is paid.

Final Thoughts

Despite all of these risks, you still might decide you need to help out. You do have rights as a co-signer and you can take steps to protect yourself should the worst happen. You can request the lender stipulate in the contract that you are only responsible for the principal balance in the event of default. You can also request notice in writing if the borrower ever misses a payment, which will give you some time to talk to the primary borrower and make financial arrangements before you’re faced with a collector.

This is the type of request that can be very difficult to say no to, but you want to make sure that you remember you can say no. Entering into this kind of a contract with a friend or family member can lead to financial troubles and strained relationships. Can you afford that?

Photo by Muffet.

About the Author

By , on May 4, 2013
Emily Guy Birken is a freelance writer, recovering English teacher, and stay-at-home-mom. She lives in Lafayette, Indiana, with her mechanical engineer husband and infant son. Her musings on life and parenting can be found at The SAHMnambulist.

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{2 Comments}

  1. Kelly says:

    This would definitely be an awkward conversation to have, but it would be a lot smarter in the long run if you don’t have complete trust in the person/people. Many times kids will need a cosigner for apartments and cars, and as a parent thats a different story compared to co-signing for a friend.

  2. This is a great article for anybody, even if they aren’t planning to cosign right now. It has wonderful information that anybody who wants to protect themselves and their credit should know. Thanks for sharing.

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