Should You Co-Sign a Loan?

by Miranda Marquit · 8 comments

co-signing
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.

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  • Ryan G says:

    A few points on co-signing:
    1) You and the other party should have clear expectations on payments going in, and what happens if you have to take over payments if the other person can’t pay. Say you co-sign for a car loan for a family member. If you have to start making the payments, you should have a clear agreement as to what happens to the car. Do you get to take the car away? Does it get sold? If I co-signed a car loan, and I had to pick up the payments, I would want the car sold to pay off the loan AND ensure I recouped any payments made.
    2) Carefully evaluate what you are co-signing for. Ensure that the loan is being used for something with some tangible value to cover the cost of the loan. Otherwise there is nothing to secure the debt. If you co-sign for an unsecured loan, you need to be willing to take over all of the monthly payments and be OK with never seeing that money again.

    • David Ning says:

      Great point about writing down what happens to the secured asset if you have to take over a co-signed loan. Many people would worry about the payments, but few would think of the asset until they need to jump in to save their credit.

      The more you think of ahead of time, the better off you’ll be so do your due diligence!

  • Jonny Pean says:

    “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.” I feel that’s where the problem lies. What if the borrower himself fails to estimate his repayment capacity and goes on to promise the co-signer that he will make payments consistently? I remember my mom asking her best friend to co-sign a home or personal (I don’t remember exactly what it was) loan but she refused after studying the terms of agreement. However, that never went on to impact their equation. Such decisions should never be guided by emotions and both the parties should understand that. Saying no (if required) becomes easier as such

    • David Ning says:

      Good for your mom to say no, since I’m sure it wasn’t an easy thing to do.

      Co-signing is basically taking on the debt yourself. Not only are you on the hook for the payments, but it also means your own capacity to borrow money reduces. Saying yes to co-sign is really only for very unique circumstances.

  • My grandfather told me never to cosign a loan unless you want to consider it a gift. He made one exception for his brother in law back in World War II who was enrolled in the Army. He knew he was good for it, or just wanted to help him out I don’t know which.

    • David Ning says:

      Your father is a good man, and being nice must have helped the brother in law immensely. Co-signing a loan is taking a huge risk, but risks do pay off, as in your grandfather’s case.

      Decisions decisions decisions.

  • Two Donate says:

    Can I say Hell NO to that question. Even if that person is your kid(s), parents, or partner. If that your kid(s), parents, or partner stops paying guess who the lender is going to come after? Or even worse, when that person dies, the debt collector is coming after you to pay their bill(s). So again, do not co-sign for anyone what so ever.

    • David Ning says:

      Co-signing is basically saying that you share the payment. There’s really no other way to explain it. If you are prepared to make the payments by yourself, then do it. Otherwise, don’t.

      It’s that simple!

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