5 Reasons Why Cosigning for a Loan Is Always Bad News

Would you cosign for a loan for a loved one?

Jun 21, 2014 at 2:29PM
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Source: Tim Pierce.

Suppose a loved one or child approaches you and asks you to cosign on a loan.

Maybe he or she needs help purchasing a car or home and promises never to miss the monthly payments. Your loved one explains that he or she doesn't have an established credit record or has experienced problems with credit in the past.

Would you cosign for the loan? It's a difficult position to be in, but one that many Americans face. You want to help your loved one out, but you know there are risks involved. What do you do?

For millions of Americans, the answer is to cosign the loan and hope that your loved one stays true to their word. But for people who agree to cosign a loan, there can be severe consequences if the borrower misses a payment or defaults.

Before you agree to cosign a loan, understand the risks and repercussions that could arise. The Federal Trade Commission says that as many as three out of four cosigners are requested to make payments on loan. Those are incredible odds that you might be called upon to pay money for your loved one.

Cosigning a loan is a risky proposition.

Doing so means you are essentially taking on all of the legal obligations and responsibilities for the account. That means the loan will appear on your credit report. If the borrower you are cosigning with misses a payment or defaults on the loan, your credit report will show the delinquencies and you might be required to pay.

Even before cosigning for the loan, understand that the lender (also known as the "creditor") must spell out your obligations in a cosigner's notice. The notice will spell out the risks that you could be getting yourself into, which according to the Federal Trade Commission are:

  • You are being asked to guarantee this debt. Think carefully before you do. If the borrower does not pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.
  • You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increases this amount.
  • The creditor can collect this debt from you without first trying to collect from the borrower (note: this depends on the laws in your state). The creditor can use the same collection methods against you that can be used against the borrower, including suing you or garnishing your wages. If this debt is ever in default, that fact may become a part of your credit record.
  • This notice is not the contract that makes you liable for the debt.

Here are five reasons why you should avoid cosigning a loan:

1. You can't afford to pay if your loved one defaults.
Suppose that your loved one defaults and you are asked to pay the loan. Can you afford to do that? What impact might cosigning have on your own personal finances? If you can't afford to make the loan payment, you need to think twice before cosigning on the loan.

If you don't pay for the loan when your loved one defaults, you could be sued or your credit rating could be damaged. You might want to ask the lender to estimate the amount of money you would owe if the borrower defaults. The creditor isn't obligated to do this, but it doesn't hurt to ask.

2. You want to take out other loans.
The cosigned loan is considered one of your obligations, even if you are just doing it to help out a family member or close friend. Depending on your liability for the loan, you might be prevented from getting other credit. So if you are thinking about taking out a loan for yourself, then you might not want to cosign just to help out another borrower.

3. You aren't organized.
If you already have trouble organizing your own finances, what will it be like if you have to keep track of your loved ones? You can't just blindly believe he or she will make the payments on time all the time.

Even if you trust your loved one, for your own bookkeeping purposes, you should check to make sure the payments have been made online or by calling customer service. In fact, even before cosigning, you might want to ask the creditor to notify you in writing if the borrower misses a payment or makes any changes to the terms of the loan.

4. You don't trust the borrower.
How much do you trust the loved one asking you for a loan? You could potentially be forming a long-term commitment to him or her. Do you truly believe he or she can make payments on time? Is it likely that the borrower could become ill, unemployed, or might find him or herself in a position where they can't pay the loan off? If there is any hesitancy about the trustworthiness about your loved one, it might be a sign that you need to decline cosigning a loan with them.

5. It will ruin your relationship.
Financial trouble is a quick way to ruin any relationship. What impact might co-signing the loan have on your relationship with your loved one? Will you be able to forgive them if they miss a payment or default? If cosigning a loan might irreparably damage your relationship, it might not be worth the trouble.

If you do agree to cosign a loan, you want to make sure that you get copies of all the important papers, such as the loan contract, the Truth-in-Lending Disclosure Statement, and warranties. You might have to get copies of these documents from the borrower. These documents could protect you from paying fees or penalties down the line, should your loved one default on the loan.

In addition, when you ask the creditor to calculate the amount you might owe in case your loved one defaults, you might also see if you can negotiate terms of your obligation on the loan. You could potentially limit your liability to just the principal on the loan before cosigning — making sure a statement of your obligations is included in the contract. Also, check your state laws for your cosigner rights.

This article 5 Reasons Why Cosigning for a Loan Is Always Bad News originally appeared on My Bank Tracker.

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