Co-Signing A Loan: A Foolish Mistake?

By on November 23, 2012 No Comments

Co-signing sounds like a great way to help someone in need.  Someone you know needs a loan or some other type of security guarantee – maybe it’s for school, a car, or an emergency payment for home repairs or medical expenses.  They won’t get approved for the loan on their own, but everything will be fine if you co-sign with them.

Co-signing a loan usually comes from a place of caring and a desire to help.  The person co-signing KNOWS that their friend or relative is a good person – it’s just that the bank isn’t being fair.  They honestly believe that co-signing is just a formality and that they’ll probably never hear about it again.

Believe It Or Not, Banks Know What They’re Doing

Let’s start with a simple truth: There’s a very good reason that people get rejected for a loan.  If the banks give out too many loans that default, they lose money.  It’s in their best interest, as a business, to only lend money that they have a reasonable expectation of getting back.  The higher the risk, the higher the interest rate they charge to make up for it.

So if you can’t get approved for a loan at all, you may have a bad credit history and the bank doesn’t think you’re worth the risk.

Now you might be thinking “But I KNOW this person.  I know they’ll pay it back.”  Of course you believe that, but, like exciting investments, new business ventures, and casinos, most people only see the upside to all possible outcomes.

Risks Of Co-Signing

First off, you must understand that co-signing makes you 100% responsible for your side of the agreement.  The person borrowing the money doesn’t have a greater obligation to pay it back, and a creditor will not prioritize the actual borrower when looking for payment.

As well, defaulting isn’t just some nightmare scenario where your friend or relative escapes the country in the dead of night.  Maybe they lose their job and miss a payment, or have an unexpected medical expense that they have to take care of.

If you’re in a stronger financial situation than they are (and you are, since you’re the one co-signing), you might be the first target as it’s easier to get money out of you than them.

Consequences Of Co-Signing A Loan

The main two are being liable for the amount borrowed and damage to your credit score.

As well, if you apply for any type of loan, it will appear to other lenders that you’ve borrowed more than you actually have – there’s no special section for co-signed loans where you didn’t actually receive any of the money.

The final consequence is completely ruining your relationship with the person you co-signed for.

 The Only Question You Need To Ask Yourself About Co-Signging

If your child needs a co-signer on a lease, ask yourself if you’d be willing to pay their rent if for whatever reason they can’t.

If you’re thinking about co-signing for a line of credit so your sister can start a business, ask yourself if you’d be willing to pay every penny of that back.

For every situation, ask:

“Am I willing to pay back the entire amount?”

Don’t talk your way out of this question and don’t tell yourself it will never happen.  You owe it to everyone involved in the situation to approach this with both eyes open.

If your answer is yes, then go ahead.  If you’d be reluctant to pay it back, or if it would ruin your relationship with that person, avoid it at all costs.

Alternatives To Co-Signing

We understand this can be an awkward situation.  A close family member or friend approaches you and asks for help.  It’s hard to say no.  That’s why having some alternatives can help.

Do you have the money?  Is it possible for you to lend the money directly?  By keeping the banks out of it completely, your “only” risk is not getting the money back and ruining the relationship.

Can you help them get the money any other way?  Maybe you can think of other avenues to take, or different options where they don’t need such a large loan (they may qualify for a smaller one), or where they don’t need one at all.

Remember, you’re not being a bad friend or relative for saying no.  You’re saving your relationship and probably a lot of money by doing so.



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