Why you should think twice before co-signing a loan, according to experts
shironosov / iStock.com
There are many scenarios in which co-signing a loan might seem like a good idea. For example, maybe one of your kids has just started college and you’re considering co-signing their student loan. Or maybe you have a family member or close friend who wants to take out a mortgage, but their credit is poor.
See: 9 bills you should never put on automatic payment
Soon finished! Nominate your favorite small business by July 25 for the Small Business Spotlight
College and homes are prohibitively expensive for some people these days, so it’s understandable that these situations can arise. However, co-signing a loan involves many risks. In fact, the pros almost always outweigh the cons.
Here’s why, according to experts, you should think twice before co-signing a loan.
You may be responsible for late/missed payments
The first thing to know about cosigner loans is that you are responsible for the payments on the loan. In other words, if the person whose loan you co-sign doesn’t make the payments, you can be held liable. “Unlike credit cards, where the authorized user is not responsible for payments, a co-signer is,” says Vashon Gonzales, chief operating officer at KAPED.
Gonzales says he’s a debt collector and can understand the benefits of adding an authorized user to a credit card. But he doesn’t see how co-signing a loan is a good idea. “With a co-signer, they sign a mutual agreement that they will bear all the consequences if the borrower doesn’t pay, including personal credit damage, lawsuits, and even liens or repos,” Gonzales says.
You may be harassed by debt collectors
You may think that since a loan you co-sign isn’t “your” loan, debt collectors won’t harass you for missed or late payments. Not so, experts say.
“If the primary borrower does not repay the loan as agreed, you are legally responsible for the debt,” says Leslie Tayne, founder and chief counsel of Tayne Legal Group. “Plus, you could be sued or have your wages garnished if the account defaults.” Unless you are prepared to face the consequences on behalf of the primary borrower, you may want to reconsider signing a legal document with them.
See our list: 100 Most Influential Money Experts
It can hurt your credit history
Loans are a form of credit and as a co-signer you are responsible for ensuring that the loan is repaid. “Any missed payment will cause your credit score to plummet,” says Tayne. “Also, co-signing a loan for someone else could make you ineligible for credit when you need it. This is because a lender may think you are already financially overburdened.
Credit is one of the most common ways most people pay for major purchases. If you’re planning to finance a new home or car in the near future, it might be best to avoid co-signing a loan. You might even have trouble opening a new credit card if you co-sign on a loan and it becomes a problem. Unless you’re paying with everything in cash, co-signing a loan can mess with your finances.
Escaping co-signer responsibility is difficult
If all goes well with the loan you co-sign, you will be released from liability when the primary borrower finishes repaying the loan. But what if things don’t go so well?
If the loan becomes a problem and you want to escape your cosigner responsibilities before the loan is paid off, it’s not that easy, says Tayne. “The primary borrower must qualify to refinance the debt in their own name only. Since they needed your signature to get loan approval, it will likely take them some time before they can refinance it.
It can ruin relationships
Here’s the thing about money: you can always make more of it. But when relationships break down, no amount of money can fix them. If you co-sign a loan for a friend or family member and they don’t repay, you might end up resenting them. Imagine being sued, having your wages garnished, or both. Experts have seen it ruin relationships, and it could make co-signing a non-starter, even more so than the financial risks.
“You might feel pressured to co-sign a loan because you don’t want to create a rift in your relationship,” says Howard Dvorkin, president of Debt.com. “Unfortunately, in three decades as a CPA and financial advisor, I’ve seen co-signing create even greater divisions. I saw him end those relationships.
More from GOBankingRates