Know the risks before signing on the dotted line
You may think that you are helping your loved by agreeing to cosign a loan for them but you there are several reasons that this is a bad idea. Cosigning can be helpful because it allows the person you are helping obtain that student loan, car or apartment that they may not have been able to qualify for on their own. You will feel better for being able to help them and they will be able to build their credit for their future. These are typically the reasons that most people use when they rationalize cosigning for a friend or family member. However the reality is that this person either has no credit or has proven that they are not trustworthy which is why they are calling you in the first place. These are warning signs and should be considered carefully before signing on the dotted line. Below are the top 5 reasons that you should avoid cosigning at all costs.
1. They won’t care about your credit score
If this person is unable to qualify for the loan on their own because of past payment history this is a red flag that should not be ignored. Banks have decades of experience with borrowers and they calculate the likelihood that people will pay back their loans using metrics that are usually pretty accurate. While you may not have the benefit of thousands of data points you do have access to your memories of your loved one’s past relationship with money. Have they had judgments against them from other lenders? Do they always seem to have an excuse about why they can’t pay their bills? Do they often borrow money from you or other people? These are signs that this person is not responsible and you will most likely end up paying the loan yourself. If they didn’t pay their loans previously the odds are very high that they don’t have a problem with their own bad credit and will not think twice about damaging yours.
2. You will be sued first if they don’t pay.
If they stop making payments on the loan the banks, in most states, will sue you first. Once the person stops paying the loan the bank will begin collections with you directly. This usually happens within the first 3-6 months of late payments. If they are unable to setup a payment plan with you directly they will begin collections. You will now have both late payments and collection activity on your credit score. With payment history making up 30% of your credit score this can cause a loss of 50+ points on your score. The only way to improve this section of your score is through timely payments or if the company agrees to remove the late payments. Getting those late payments removed is difficult to do so you will be stuck with this ding on your record. If you refuse to pay then the companies will also be able to sue you and garnish your wages. The only way to avoid this is to setup a payment plan and begin making payments yourself.
3. It can be harder for you to get a loan when you need it
When you cosign for someone the full amount of that loan shows up on your credit report. This raises your debt-to-income ratio and can make it difficult for you to get a loan for yourself. If you cosign for a car for your friend and two years down the line you attempt to get a loan for yourself you may be denied or have smaller loan options available to you. The bank will see that you already have a similar loan and adding to that amount may exceed what your income says you could afford to pay. This is true even if your loved one is making on-time payments and has never been late. The total amount of what has been borrowed can keep you from getting a house or car when you need it most.
4. Your relationship may be ruined if they fail to pay
If you’re loved one fails to pay back their loan it could strain or ruin your relationship. Nothing destroys a relationship faster than money. Think about how you would react if you had to delay your dreams because you were paying the balance on your friend’s car. How would you feel knowing that you are struggling to make their loan payments but you see them on social media taking vacations and buying expensive things? This can make you angry and resentful. These are two emotions that make relationships irreparable. It may be uncomfortable to turn them down now but it would be even more upsetting if you lose that family bond or years of friendship.
Is it ever a good idea to cosign?
Even with the above mentioned reasons to avoid cosigning there may be times that you are compelled to do it anyway. Typically cosigning for a spouse for joint purchases like a house or car is a pretty good risk as this is an item that will be used by both of you. In these situations it is also less likely that one of you are able to qualify for a large purchase like a house on your own so this is fairly common. Also parents will cosign for student loans for their children that are going to college as well. They do this in order to help their child establish credit as well as pay for college. There is a chance that the marriage ends in divorce or the child drops out of college and doesn’t pay back the loan but most people consider these acceptable risks. While they are acceptable they are still risks and should be considered with great care. If you make an informed decision you will be less likely to be caught unaware later.