About halfway through my freshman year in college, the ancient car my parents sent me with died. I decided then that I wanted to buy my own car to replace it. Only problem? I didn’t have the cash to pay for $3,500 car, and I didn’t have the credit to get a car loan.
My parents came to my rescue, agreeing to co-sign a loan for me. They helped me open an account at their credit union and then co-signed on a loan with the lowest interest rate possible. I made payments faithfully until that car was totaled in an accident a couple months before the last payment was due. (The insurance payoff allowed me to finish paying the loan with enough left over to make a 50% down payment on the replacement car, though.)
This arrangement helped me build my credit so that I could get my next car loan on my own merits. And, because I was consistent in my payments, it didn’t harm my parents’ credit, or cost them any money. This isn’t always the case, unfortunately. Before you co-sign a loan, consider that, according to CreditCards.com, 40% of co-signers lose money, and there could be other ramifications.
What Happens When You Co-Sign a Loan?
First of all, it’s important to understand that you accept responsibility for the payments when you co-sign a loan. Basically, you are putting your own money and your own credit on the line. You agree to make payments (or pay off the loan) if the borrower doesn’t. This means that you could lose money if you co-sign a loan for someone else.
Another consequence is that your credit can be impacted. If the borrower misses payments, that is reflected on your own credit history. Even though you aren’t the borrower, you have accepted responsibility for the loan, and that means that your credit is also affected if something goes wrong. If you co-sign a loan, you need to make it clear to the borrower that s/he should let you know if payments can’t be made so that you can step in and save your credit.
Speaking of credit, the loan you co-sign will also impact your available credit. It will look like a loan on your credit report, and “count” against you if you apply for other loans. Depending on your situation, you might not be approved for other loans if you have a co-signed loan dragging on your available credit or if it impacts your debt-to-income ratio. Having that payment listed might put you over the top of the acceptable ratio if you plan to apply for a mortgage. Before you co-sign a loan, consider what kind of loans you might want in the future.
Could Your Relationship Be Affected?
Relationships can also be ruined by co-signed loans. Are you resentful if the borrower doesn’t make payments? What happens if you push for repayment? Could the arrangement add tension to the relationship?
Carefully think of the financial and emotional consequences before you co-sign a loan. You might feel like you are helping, but if there isn’t true need involved, or if you are concerned about the ability to be responsible about it, you might be better off when you avoid co-signing.