What to know before you agree to co-sign a loan
Loan co-signing is a highly charged topic. On one hand, many people who co-sign loans are asked by close family members, so they may feel obligated and don’t think twice before putting pen to paper.
As with any financial decision, it is best to put aside the emotions and look at the facts. You aren’t being a bad family member if you say you need to think about it before agreeing, and you don’t have to say no just because you’ve heard the horror stories. The following information will help you think critically about co-signing so you can start determining what choice is best for you.
It is reasonable to take co-signing a loan very seriously because there are serious repercussions if the person who took out the loan can’t pay. Many people look at the task of loan co-signing as simply acting as a character witness. They have good credit and know that a financial institution trusts them with loans, and by co-signing, they are making it clear that they trust the person they co-sign for.
This is a dangerous way to think about the process, however, because you aren’t simply helping the financial institution make a decision about the borrower. Lenders don’t care about your opinion, they only care that there is someone who will definitely be able to pay. Be sure you understand that you aren’t just adding your credibility to the loan agreement, you are actually lending your assets.
When you co-sign, you are agreeing to pay for the loan, as well as any fees, penalties and other associated costs if the other party cannot. Depending on the specific loan and the state you live in, the lender may even take legal action against you if the loan is in default before attempting to collect from the other party. While this is a scary idea, it makes sense because the co-signer is the one most likely to be able to pay, and the financial institution doesn’t want to waste their time pursuing someone who has already demonstrated an inability to pay.
“By co-signing, you take on all the risk if the loan is not repaid but may only see a modest improvement to your credit score,” states Justin Harelik from Bankrate. “Even worse, the person who you helped most likely has bad credit. So he or she does not care whether another negative mark appears on his or her credit report. Needless to say, you have much more to lose.”
Even if you completely trust the person you agree to co-sign for, there are circumstances that can change your relationship in unexpected ways, so you must be fully prepared to pay when you co-sign. Divorce is an obvious example of good relationships gone wrong, but even co-signing for your children carries risks. There have been many tragic incidents of parents who are left to pay back student loans they co-signed prior to their child’s incapacitation or death. In some cases, financial institutions will negotiate or dismiss loans if a tragic death is involved, but you can’t count on that happening.
Now that you’ve fully considered the seriousness of the subject and the potential consequences, it is important to note that the big risks do indeed confer big rewards on the person you help, so you shouldn’t just say no automatically. Many people would be unable to further their education, get a car or a mortgage without a co-signer and many co-signers never end up paying a dime.
If you would be able to pay in an emergency (this is non-negotiable), and you want to help the other person, there are things you can do to make co-signing safer. First of all, if you are co-signing loans for a child, they can take out a life insurance policy with you as the beneficiary. So, if a tragedy does occur, you have a means of repayment that doesn’t drain your bank account.
You should also speak with the lender to determine the exact amount you might owe, so you can be prepared. You can also try to negotiate the terms so that you are only liable for the principal and not fees and penalties, for example.
“If you’re co-signing for a purchase, make sure you get copies of all important papers, like the loan contract, the Truth-in-Lending Disclosure Statement, and warranties,” recommends the Federal Trade Commission’s website. “Ask the creditor to agree, in writing, to notify you if the borrower misses a payment or the terms on the loan change. That will give you time to deal with the problem or make back payments without having to repay the entire amount immediately.”
Last, make sure you realize that co-signing becomes part of your finances. This means it may impact your ability to take out a loan for yourself. So, if you plan to buy a vacation home or take out another large loan in the future, co-signing may not be feasible even if all the other pieces of the puzzle look good.Used with Permission. Published by IMN Bank Adviser Includes copyrighted material of IMakeNews, Inc. and its suppliers.