Risks of Cosigning a Loan
A friend or relative asks you to co-sign a loan. He or she assures you that the loan will be repaid in full and you'll never be called upon to cough up the cash due to default. Being the nice person that you are, you agree, but before you sign those papers, make sure you know the risks and how to protect yourself. Studies conducted among certain types of lenders revealed that of all the co-signed loans that go to default, as many as three out of four co-signers are required to repay the loan.
Remember, your friend or relative has asked you to co-sign because he or she has been turned down for credit by a professional lender. Sometimes this is due more to a lack of credit history than bad credit, but the reality is that a lender, who is in the business of lending money, felt that the borrower is too much of a risk. This should give you pause for thought. In most states, if the borrower misses a payment, the lender can come after you first, without trying to collect from the borrower. You could be required to pay late fees or attorney fees, you could have your wages garnished, you could lose any property you pledged against the loan or you could be sued.
Before you co-sign for a loan, be sure you can afford to pay the debt if the borrower defaults on the loan. You may feel confident that this won't happen, but consider the unexpected: people lose their jobs, become ill or disabled, or die unexpectedly. Others are just irresponsible. When you co-sign a loan, be sure you are capable of repaying the loan, and that it wouldn't cause a financial hardship or jeopardize your own credit. The loan you co-sign will show up as a liability on your credit record, which may prevent you from obtaining credit yourself. If you're planning to buy a house, car, or other large purchase during the life of the co-signed loan, you may want to think twice.
Despite the risks, there are times when it makes sense to co-sign a loan. For instance, many parents do it for their kids to help them establish credit. If you do decide to co-sign a loan, try to get the lender to agree in writing that in the event of a default, you would be responsible for only the principal balance of the loan. This would protect you against legal fees if the lender decided to sue.
Also ask the lender to agree in writing to notify you if the borrower is late with a payment. This could give you valuable time to try to rectify the situation before it gets out of hand. Make sure you get copies of all the paperwork for the loan. If the lender won't give them to you, get them from the borrower. Before you make the decision to co-sign a loan, you should know the purpose of the loan, type of loan, and terms of the loan. The bottom line is that you should treat co-signing a loan as if you were borrowing the money yourself, because when push comes to shove, that's exactly what you're doing.