4 Questions to Ask Before Cosigning a Loan

The answers could make all the difference in whether you should say yes or not.

When you cosign a loan, you're taking on a huge financial responsibility. Sure, the primary borrower is theoretically supposed to be the person who pays off the loan -- but you're promising the creditor that you'll be responsible if they don't do that. If the borrower is late making payments or they default, your credit will be damaged and creditors will try to collect the money from you.

There are some circumstances where you may decide to say yes to cosigning despite the risks. But if you're thinking about sharing liability for someone else's loan, be sure to ask these questions first.

1. Why do you need to borrow?

It may seem intrusive to ask someone why they need the money. But if you're going to guarantee a loan for them by cosigning, you deserve to know why they're asking you to take on this big risk.

Their reasons for borrowing can also help you decide if you want to put your credit score and money on the line to help them. After all, there's a big difference between cosigning for a personal loan for your child so they can get fertility treatment or pursue a career change -- and cosigning for a friend so they can pay for a big vacation.

2. What is your plan to repay the loan?

When you cosign, you need to be confident the primary borrower is going to pay back the loan in full -- otherwise, you'll get stuck with the bill. Because of that, it's important to find out what their plan is for coming up with the money.

If they already have a good job with a stable income and room in their budget for debt payment, there's a very good chance they'll make payments on time and in full. On the other hand, if they only have a vague goal of getting a better job after borrowing but no concrete idea of how they'll do it, you may want to proceed with caution.

3. How will you pay if your income is reduced?

Unfortunately, for most people, there's always a risk that a reduction in hours or a job loss could cause a drop in their income. You need to know what the primary borrower's plans are if that happens.

If they have an emergency fund set up or a spouse's salary they could rely on temporarily, they could probably still pay back the loan if there are any bumps in the road. And that probably means less risk for you.

4. When will the debt be paid off in full?

The longer the loan repayment period is, the bigger the burden cosigning becomes. There are two reasons for that.

First, there's a greater chance of repayment problems developing over a very long period than over a short one. After all, if it takes 10 years to pay back the debt, there's a lot more time for illness, job loss, or other unforeseen events to pop up and cause problems than if loan repayment takes just two years.

Second, the entire time you cosign, the debt shows up on your credit report. That means your own ability to borrow could be affected if your debt-to-income ratio is too high -- even if everything goes well and payments are made on time.

If the primary borrower has a good reason to take out the loan, you're confident in their ability to pay, and the debt will be paid off in a short time, then you may decide to say yes to cosigning. Just remember, even in the best of circumstances, you're still taking a big risk -- so be sure that if the person you're cosigning for defaults on the loan, it won't be financially devastating to you.