Have you been asked by someone to co-sign on their loan? Before saying yes, even if it is a close relative, you should be aware of the many potential consequences to your own financial situation which could result from the decision. Here are some facts that you should consider:
► As a co-signer, you are essentially taking the loan out yourself. You share in all the responsibilities that go along with the loan. The borrower couldn't get the loan without your "guarantee", so essentially the lender cares more about you than the other borrower. It directly affects your credit and your ability to qualify for your own loans during the period that the loan is outstanding.
► Your credit score is affected. If a payment is made late, you are responsible and the negative history shows up on your credit report. Some people think it will be easy to explain that it really isn’t your loan, but it doesn’t work that way. In the eyes of banks, if you are willing to co-sign for a loan, you should be willing to make sure it gets paid back properly.
► Your ability to qualify for your own loans is decreased. If you could qualify for a $3,000/month payment on your own before co-signing, and you co-sign a $500/month loan for someone else, you are most likely going to be limited to around a $2,500/month loan for yourself.
► Consider the length of the loan. You may have an exit strategy that includes refinancing in a few years, but anything can happen in that time. Rates could go way up and make refinancing unfeasible. The person you are co-signing for could lose their job… or worse. As it is, you are signing on for the life of the loan, so consider the worst-case scenario of being stuck for the entire term.
► Consider ownership rights of the item you are co-signing for. If you are co-signing on a loan, you should make sure you also have ownership of the property, just in case the worst happens. You don't want to be stuck with the obligation to make payments for something that is not yours.
► Consider consulting an attorney on what you can do to protect your interests. If the attorney doesn’t talk you out of it, then consider drafting an agreement between you and the party you are co-signing for that gives you some ownership control in case they can't make the payments.
Obviously, if you are considering co-signing on a loan, you have a close relationship with the person you are helping. However, be sure to go into the situation with your eyes wide open! Make sure that you are fully aware of all the things that can go wrong along with the potential consequences.
