The Risks You Take When You Co-Sign a Loan for Someone Else
Being a co-signor is a generous act to help your family or a friend get a loan for which they otherwise do not qualify. In matters of finance, being generous can be risky too, especially when you promise to pay off somebody else’s debt if the borrower defaults.
When you co-sign, you…
- Help the borrower get a loan for which they don’t qualify either because of low income, no credit history, bad credit history or low credit score.
- Take on the responsibility to repay the loan if the borrower isn’t able to.
When does someone ask you to co-sign?
- When they don’t qualify to get credit on their own.
- When the lenders suggest them to get a co-signer with a strong positive credit history to strengthen the loan application.
The reason lenders take on a co-signor is when they do not have the confidence that the primary borrower can repay in full and on-time.
It’s great to help somebody get a loan, but it’s a huge risk.
So, you better have a good reason to take the risk when the professional lender isn’t willing to.
Risks of Co-Signing a Loan
1. It may harm your credit.
If your borrower doesn’t make timely payments or misses payments, it doesn’t reflect well on your credit report. Your credit score may dip, and it may get harder to get a loan if you ever need one.
2. You are as responsible for the loan as the borrower is.
Lenders expect payments on the loan regardless of who is paying, you or the borrower. And they take up the path of least resistance to recover their money. Since you got yourself in the deal, it might be easier to get the funds from you. The lender may pester you for repayments with calls, SMS, letters, emails or even with a legal notice.
3. Yes, legal action can be taken against you.
If payments are not made, all attempts are made to recover the borrowed money. That may even include a legal action. Moreover, all these attempts reflect in the borrower’s credit history as well as yours.
4. It’s harder for you to qualify for a loan.
When you co-sign, you agree to take the responsibility of repaying the loan. When you need a loan for yourself, the lenders may consider the loan for which you co-signed and assume that you’ll be making the payments. Co-signing, therefore, affects to debt-to-income ratio making it difficult to get a loan for yourself even when you are not the one making the payments. This may prevent you from buying a house or sending your kid for higher education.
In a nutshell, co-signing is all risk with no benefits for you at all.
If you are not willing to take the risk, avoid co-signing.
But if you have to co-sign for your family or a close friend, these tips can help you manage risks and protect yourself from ruining your relationship and your credit.
- Stay connected with the primary borrower. Encourage frequent communication.
- Ensure that you have access to repayment history and loan information. Sign up for alerts, either for email or SMS alerts.
- If the primary borrower defaults on a payment, make the payment yourself so that your credit score doesn’t suffer. This surely isn’t what you want to do, but you have signed up for this. Obviously, you can’t keep making payments so get in touch with the borrower to find out the reason for default and get them on track.
Before you co-sign, give the borrower an alternative of getting a personal loan through online lending platforms, which may comparatively have less stringent eligibility criteria. If the loan gets through you may not need to be a co-signer, and that could be a relief.