Not too long ago, a family member asked me if I would be willing to co-sign on a loan. It was a somewhat large loan. I felt queasy at the thought. I’ve helped this relative out in the past, always with money that I don’t expect to be repaid. (My rule of lending to family: Don’t. If you can make it a gift, do that. If you can’t afford it, say you’re sorry, but you can’t help with money right now.)
However, I do have a good out. With everything that’s going on right now, we can’t really afford to take on that kind of debt obligation. We might have to move. Credit checks might be performed before we can get into an apartment or buy a different home. There are a number of obligations coming up, and we need our credit situation flexible. So I said that we probably couldn’t.
My relative was understanding of the situation, and I gave this person some alternative ideas to getting some of the money he needed without the need for a co-signer. But the question threw me back into thoughts of whether or not it makes sense to co-sign for someone else.
Are You Prepared to Take on That Debt?
Technically, the borrower is supposed to repay the loan. In a perfect world, you co-sign on the debt, the borrower makes payments on time, builds a bit of a good credit history, eventually pays off the loan. This is a nice theory, but what happens if the borrower doesn’t pay?
When you co-sign, you agree to take on that obligation. So, if the borrower doesn’t pay, you have agreed to cover the debt. So you need to be in a position to pay off that debt — just in case.
Other Consequences of Co-Signing a Loan
You don’t just have to be ready to pay the debt. There are other consequences associated with co-signing a loan. First of all, the obligation is seen as yours. So, even though the borrower is supposed to be making the payments (and even if the borrower is making the payments as agreed), the debt “counts” against you. When prospective lenders look at your debt load trying to make a determination, they will consider the possibility that you will have to pay that debt — and that means you might appear to have a higher debt-to-income ratio than you technically have.
If the borrower ends up missing payments, that will reflect on your credit as well. So, even though it isn’t your loan, you’ve claimed responsibility for it. When payments are missed, it can drag down your credit score. This is part of the incentive you have for making sure that the borrower is paying on time.
This can lead to other issues, particularly those having to do with your relationship. If you are afraid that your relative’s habits could lead to a drop in your credit score, you might constantly be keeping tabs on what he or she is doing. That kind of nagging (did you pay your bill on time?) can ruin a relationship. Even worse is if the borrower does default and you are stuck with the consequences. That can lead to a great deal of resentment on your part.
When Co-Signing Can Make Sense
The idea of co-signing a loan is one that should make you think twice. However, there are times that it might make some sense co-sign for a loved one. You might be able to help them when they really need it. But before you sign on the dotted line, here are some questions to honestly answer:
- Do you trust this person to repay the loan?
- How well does this person manage money?
- If there was a problem, would the person come to you immediately to work it out, or would he or she try to hide the issue?
- Can this person actually afford the loan payments?
If the answers to these questions don’t fill you with confidence, you shouldn’t co-sign. There are times when parents co-sign their children’s loans (my first car was bought with my parents’ co-signing help), but it gets sticky otherwise. And, even in the case of a child, I’d be wary of putting my own financial situation at risk.
What do you think? Does it ever make sense to co-sign a loan?