3 Reasons to Say No to Cosigning a Loan

Should you cosign a loan? While helping out a family member or friend may seem like a good idea, there are some big reasons to say no.Image source: Getty Images.

So your family member or close friend wants to take out a loan and is asking you to cosign. Should you say yes?

Typically, cosigners are required when someone can't qualify for a loan on their own, often because they have a low credit score, no credit, or an income the lender considers too low. Sometimes, a cosigner is required so the primary borrower can get a better rate because their own financial credentials don't qualify them for the most competitive terms.

While it might help out your friend or family member if you agree to cosign, saying yes and signing your name to a loan document as a cosigner could be a big financial mistake for you. It's a mistake you should avoid -- by saying no to cosigning -- for all of the following reasons.

1. You become legally responsible for repaying the debt

If you cosign a loan, you're agreeing to be held legally responsible for repaying the debt. The creditor can collect from the primary borrower -- or from you. If the primary borrower doesn't pay, you could end up having to pay back the entire debt out of your pocket. If you don't, you could be sued by the creditor, your wages could be garnished, a lien could be put on your property, and other undesirable collection activities could occur.

It's a big deal to assume legal responsibility for someone else's debt. Even if you think the primary borrower will pay it back, something could still go wrong -- like disability or death. In most cases, if the primary borrower passes away, you'd still be on the hook for paying back the full amount owed.

Most of the time, once you've cosigned, it's almost impossible to be absolved of legal responsibility for the debt. Some lenders may allow cosigner release after a set period of time, or the primary borrower could refinance. But, outside of these situations, you remain legally responsible for repayment. Even in cases where you cosign for a spouse's debt, you get divorced, and the divorce decree says your spouse has to pay, creditors could still come after you.

2. Your credit could be ruined if the primary borrower isn't responsible

There's probably a reason the primary borrower can't qualify for a loan on their own. The lender -- who's trained to assess borrower risk -- isn't confident the primary borrower will actually pay back the loan responsibly.

This is a major red flag for you because you're putting your own credit on the line. If the primary borrower pays late, you may not find out about it right away (until the creditor starts trying to collect from you). Meanwhile, a record of late payments will go on your credit report. Even a single late payment could drop a good credit score by more than 100 points, so your own credit could be destroyed in no time.

If your credit is ruined, it could take you years to rebuild it. In the meantime, you won't be able to qualify for financing you might need. Employers and landlords who conduct background checks will see a record of late payments on your credit report, so your housing and career opportunities could be limited.

You don't want to find yourself in this situation just because you were nice enough to cosign a loan.

3. The debt will affect your own debt-to-income ratio

Because the debt you cosigned for shows up on your credit report, lenders typically treat it as a debt you owe. This means when you apply for financing monthly payments, the debt you cosigned for will be factored in when your debt-to-income ratio is calculated.

Your debt-to-income ratio is determined by adding up the debt you owe and comparing it to your income. If your DTI is too high, you won't be able to get a mortgage or many other types of loans.

You don't want your opportunities for financing to be limited -- potentially for years as the primary borrower works on paying off the debt. This is another major reason why you should not agree to cosign -- especially if the loan is a big one with a long repayment term.

Just say no if you're asked to cosign a loan

Clearly, there are plenty of reasons to say no if you're asked to cosign on a loan. You don't want to take the chance of ruined credit or damage to your own financial reputation. Not only could you jeopardize your finances, but you could also damage your relationship with the primary borrower if things go wrong. It's just not worth the risk.