6 Questions to Ask Before Cosigning a Loan

Are you considering cosigning a loan? Don't take on responsibility for anyone else's debt until you ask these questions.Image source: Getty Images.

If a friend or family member can't qualify for a loan on their own, there's a chance they'll ask you to cosign. That means your you'll essentially be guaranteeing the loan for your loved one. Your credit and income will be considered by the lender in deciding whether to approve or deny the loan, the loan will show up on your credit report, and the creditor could try to collect from you if the primary borrower doesn't pay.

Cosigning a loan is a serious matter. Your credit score will take a hit if the primary borrower fails to make payments on time -- and you could be forced to pay the loan back if the primary borrower stops making payments or passes away before the loan is paid off. And because the loan is listed on your credit report, you could have a hard time getting your own financing if it looks as though you're too deeply in debt.

As you can see, there are some big downsides to cosigning. But you may still consider doing it to help out someone you love. In that case, there are some big questions you need the primary borrower to answer before you sign your name and agree to share responsibility for that person's debt.

1. What is the loan for?

Cosigning a loan to pay for school or a car for commuting to work is much different from cosigning a loan to pay for a wedding or vacation. If your friend or family member needs to borrow for an important purpose, you may be more willing to put your own credit on the line to help their dream come true.

2. How much is the loan for?

The larger the loan, the greater the risk you take on when you cosign. After all, if you agree to share responsibility for a $1,000 personal loan, you're out $1,000 at most if you end up having to pay back the loan because the primary borrower failed to do so. But if you cosign for a $50,000 loan, you could end up being on the hook for a huge sum of money -- or facing lawsuits and damaged credit if you don't pay.

3. Why does the lender want a cosigner?

Lenders sometimes require a cosigner for one reason: They aren't confident in the primary borrower's ability or willingness to pay back the loan. Lenders are experts at assessing risk, so if they've decided the primary borrower is too risky to lend to, you need to understand why, because you're assuming the risk of nonpayment.

If the primary borrower can't qualify simply because they're young and haven't had time to build credit, that's different from someone who can't qualify for a loan because they've defaulted on every loan they've ever taken out. The person asking you to cosign is asking you to put your credit on the line, so they should be forthcoming about why the lender needs additional reassurance.

4. When will the loan be repaid?

When you're cosigning, the debt affects your debt-to-income ratio and thus your own ability to borrow. The longer the loan repayment period, the longer you'll be affected -- and the greater the chance that something will go wrong and cause the borrower to struggle to pay back the loan. If the loan you're willing to cosign has a shorter repayment timeline, then your credit report will be clear of the loan much sooner.

5. What's the plan for repayment?

Find out when the primary borrower will begin making payments, where the income to make those payments will come from, and how the borrower plans to make sure payments are made if their income is interrupted.

You also want to confirm that the primary borrower will be earning enough income to pay back the loan and has a plan in place -- e.g., having money saved in an emergency fund -- so no payments will be missed in the event of an income interruption. Otherwise, a single missed payment on the loan could do serious damage to your credit score.

6. Can you afford to pay back the debt if the primary borrower doesn't?

This is a question you need to ask yourself, because there's always a chance that you could get stuck paying back the loan. Even if the primary borrower has every intention of fulfilling his or her obligation, death, disability, or extended unemployment could simply make this impossible.

Unfortunately, if you've cosigned, the creditor can pursue aggressive legal action against you to force you to repay. Not only could you be sued, but your wages could be garnished, liens could be placed on your property, and your credit could be destroyed.

If paying back the loan would financially cripple you, you may decide you simply cannot take a chance on cosigning, even if you trust and wish to help the primary borrower.

Cosigning is a big commitment

Cosigning a loan is a major commitment, and you can't take the decision lightly. If someone asks you to cosign for any debt they're thinking of taking on, you should make sure you get detailed answers to all of these questions first. By asking the right questions, you can make a fully informed choice about the financial obligation you're taking on.