4 Crucial Reasons You Shouldn’t Cosign a Loan
If a friend or family member asked you to cosign their loan, would you?
We all want to be generous and helpful when our loved ones are in need. But there are four giant reasons why you should say “No” if asked. If you can’t think of all four, don’t answer that request until you’ve carefully reviewed the following info.
If a borrower has bad credit or no credit history, they likely won’t be able to qualify for a loan with most lenders. One option the borrower has in this case is to take on a cosigner. The lender uses the cosigner’s credit score to help qualify the loan. The cosigner is considered the guarantor for the loan.
If you’re asked to cosign a loan, it could adversely affect you in the following 4 ways:
- Your ability to qualify for a loan.
Banks and lenders treat the loan as if you had borrowed the money yourself. Even if the borrower makes their payments on time, having the debt on your record may adversely affect your ability to get a loan. For example, if you would normally qualify for a $200,000 mortgage, the bank may only offer you a loan qualification of only $150,000 if you have already cosigned on a $50,000 loan. Or you could be denied a loan altogether if you debt-to-income ratio is too high. It doesn’t even matter if you have perfect credit scores.
- Your cash flow
If the borrower fails to make their payments, the lender will expect you to pay everything—the original principle, interest, late fees, collection fees, or anything else that applies. According to the Federal Trade Commission, three out of four cosigners are asked to pay when the borrow defaults. This statistic shouldn’t surprise you—remember, if the borrower needs a cosigner, it’s because they’re already considered a high risk investment! In most states, the lender can come straight to you instead of asking the borrower first. This may expose you to phone calls from collection agencies, lawsuits or even garnishment of your wages.
- Your credit score
If the borrower fails to make their payments, your credit score could likely be harmed in the process.
- Your relationship with the borrower
Cosigners usually pledge for family members or close friends. Needless to say, if the borrower fails to pay, your relationship with that person could be irreparably harmed. It’s probably not worth the risk.
As a last piece of advice, keep in mind that the borrower does not need to be a deadbeat in order for you to be impacted. Even the most responsible individuals can suffer the loss of a job, an unexpected medical problem, or another event that affects their ability to pay. In any of these cases, you will be asked to repay the loan.
So, what can you do instead of cosigning? Here are a few ideas:
- Give them the money as a gift. The chances are good that you’ll end up paying for it anyway!
- Loan them the money yourself—with the knowledge that they may not be able to repay it all or repay it consistently. However, the one advantage to this is that your credit rating is not at risk. If you can’t give them the full amount needed, see if they can obtain a smaller loan on their own and help them out with the difference. Or consider giving them a little as seed capital or a down payment and work with them to put a budget or savings plan together for the future.
- Help them to improve their credit rating so that they can get the loan without a co-signer:
- Offer them resources on ways to improve their credit score.
- If you are an employer, hire them. If they already work for you, give them a raise. If neither, get creative and use your connections or resources to help them find a better job.
- Help them reduce their expenses. Perhaps you have real estate you can rent to them inexpensively. Maybe you have a used car you can sell them at a bargain price.