Co-Signing for a Loan: 4 Things to Consider First

by Hollis Colquhoun on 29 October 2010 0 comments

There are many situations where you might be tempted to co-sign for a credit card or loan. Here are a few examples:

  • An 18-year-old college student can't get a credit card on his own because he only did odd jobs over the summer and recent law changes require that a student be 21 or have sufficient income from a job to pay for a card. Because the child's low income doesn’t make the cut, his parents agree to co-sign for the card, hoping it will teach him how to develop good spending habits and start building a good credit profile.
     
  • A young woman is in a difficult financial situation: Her car broke down, and she needs to get a new or slightly used car to get to her job. She has to finance part of it and needs a co-signer because her credit isn't good enough. Her grandmother agrees to co-sign for the car loan.
     
  • A man wants to put an addition on his house, but he's self-employed and doesn't have a great credit score, so he asks his fiancé to co-sign for the loan since she has a steady job and a good credit score. 

Co-signing for a loan to help your child, relative, or friend sounds like a noble act, right? You’re just being the credit booster. However, everyone should be aware of the ramifications of co-signing a loan for anyone, including your child or best friend.

You Are the Borrower

Being a loan co-signer means you are the borrower in the eyes of the credit bureaus, so this loan will appear on the main borrower’s credit report as well as on yours. The timeliness of the borrower’s monthly payments could also impact your credit score if they aren‘t made each month.

Your Future Loans Can Be Affected

If you are planning to get a new loan in the near future, the co-signed loan may negatively affect your chances of getting a new loan or may increase the interest rate you would have to pay because of your higher debt-to-income ratio. 

Co-Signers Pay Back

According to the Federal Trade Commission (FTC), studies have shown that of all loans that have had co-signers and gone into default, 75% end up being paid by the co-signer. In some states, if the debt holder misses a payment, the creditor could come after you (the co-signer) for the money. Creditors and banks ask for a co-signer because the potential borrower — your child, relative, or friend — doesn’t have the credit rating and/or income to support the loan. So yes, you would be helping them with your fall-back guarantee, but you would also be responsible for the debt if anything goes wrong.

You Are Fully Responsible

If your child, relative, or friend defaults on the loan payments, not only would you be responsible for paying back the loan, you would also have to pay any late fees and accrued, unpaid interest. The worst case scenario would be that the unpaid debt goes into collections, the creditor sues you, and the court gives the creditor the ability to put a lien on your house or garnish your wages. Of course, your credit score would take a beating in the process.

Consider Carefully

Co-signing for a loan to help your child establish credit may be a good idea if you make the amount small enough that you can pay it if your child defaults, and if you set the monthly payments low enough that your child can afford them. The purpose of your co-signing in this case is to help your son or daughter establish a good credit history, so take the time to explain the consequences of good and bad borrowing behavior. Building a good report will be very important for your child when he or she is looking for a full-time job or wants to move into an apartment.

According to the FTC, a co-signer may be able to limit the potential liability in advance by having a clause in the loan agreement stating you are only responsible for the principal of the loan and that you must be notified if there is a missed loan payment. State laws vary regarding a co-signer’s legal obligation, so make sure you understand your rights and responsibilities in your state before you sign.

This is a guest post by Hollis Colquhoun. Hollis has over 20 years of experience in the financial industry, is an Accredited Financial Counselor and co-author of Women Empowering Themselves: A Financial Survival Guide. Contact her at Women Empowering Themselves. More articles by Hollis:

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