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.
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:
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.
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.)
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.
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.
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.
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