Why Co-Signing on a Loan Is Probably a Bad Idea
Lots of people – even those we love – don’t make good on promises; your credit takes an immediate hit
When someone asks you to co-sign a loan, it’s hard to contemplate saying no. Chances are the request is coming from someone you love – a child, a sibling, a bestie – and it seems hardwired into our DNA to help.
Co-signing a loan is a big financial undertaking. Even if the main borrower is diligent about repaying, your financial life is going to be impacted from the day you co-sign.
And it’s foolish to presume there won’t be a hiccup that requires you to step up and make payments. A new AARP survey reports that 25% of co-signors for student loans who were at least 50 years old had to make a payment because the borrower didn’t come through. (Note: Only private student loans require a co-signor. If your kids stick to federal loans – and they should! – there is no need to co-sign.)
Another survey a few years ago by CreditCards.com, found that nearly four in 10 co-signors end up paying out of their own pocket to make good on the debt. That’s a lot of grief.
What you need to consider before you co-sign:
Are you helping, or enabling? Ask yourself why the person can’t qualify for a loan on her own. If we’re talking about a 20-something child who has yet to build a stellar credit history – and thus will get smacked with an astronomical rate on a car loan – that may be OK. But if your older sibling or friend needs help because of a history of poor financial decisions, that should be a yellow light.
Are they borrowing the least amount possible? If someone is putting you on the financial hook, they should be motivated to keep their borrowing to a minimum. Hint: used car, not new.
Can you afford to pay back the loan? This is the show-stopper moment: Co-signing a loan is a legal obligation that you will pay it back if your relative/friend falls behind. This is not some family or friends handshake.
You OK with your credit score taking a hit? If the person co-signing falls behind on payments, it is going to cause their and your credit scores to fall.
You OK with having a harder time getting a loan for yourself? Any lender considering giving you a loan will crunch some numbers on whether you have enough monthly cash flow to cover all your loan payments. For example, mortgage lenders typically want to see a debt-to-income around 36%, though it can stretch higher. When you co-sign a loan, the monthly payment (whether you are personally making it or not) shows up as a debt that is part of this calculation. Even if you currently own a home, this could make it harder to refinance, or qualify for a new loan – at the best possible rate – if you want to move. And it will also impact any future car loans as well.
It can outlive your relationship. If you have a falling-out with a bestie you co-signed for, you’re still liable for the loan. The only way to get out of the loan agreement is if they pay it off or refinance.