Maybe you’re a parent intent on helping your new driver purchase their first vehicle or a grandparent eager to see a grandchild sign on the dotted line of their first mortgage – either way, co-signing a loan goes far beyond the warm and fuzzy feeling you might get by lending a hand.
Signing your name doesn’t just mean you’re acting as a character witness to the party in question, it means you recognize your financial liability should things go south. While sometimes this arrangement works for both parties, sometimes it can tear the co-signer’s finances to shreds.
So before you give in to the pleads of the loan-seeker, make sure you know what you are getting yourself into.
Here are a few of the financial implications of becoming a co-signer.
You Assume All Liability As a Co-Signer
Unfortunately, credit reports don’t distinguish between payments you failed to make on time and late payments made on an account you simply co-signed on. So if you’ve been diligent about keeping your payment history squeaky-clean, co-signing could tarnish your stellar reputation.
In addition, if payments on the account should cease for whatever reason, you are not only liable for the remaining balance, but your credit could plummet in the process. According to the Federal Trade Commission, the creditor has all rights to try to collect the debt from you even before the borrower, and they can use all methods available to them – suing you, garnishing your wages, etc.
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Once you’ve co-signed a loan, the creditor and future lenders see that debt as your obligation – regardless of who is reaping the benefits from the loan in the first place.
You likely won’t find out about important account changes until it’s too late.
Most co-signed loan contracts don’t include anything that states a co-signer must be notified when changes are made to a loan or if payments are missed.
Say for instance you agree to co-sign on a credit card with a set credit limit. The bank could then decide down the road to significantly increase the credit limit – without notifying you, the co-signer – and suddenly you could find yourself on the hook for far more than you originally agreed to.
If the primary borrower finds themselves in a bind and completely misses three month’s worth of payments in a row, you might not even find out about the situation until you begin receiving collection calls and notice a drastic drop in your credit score. By then, it could be quite a challenge to get the account back to good standing without draining your own accounts in the process.
You may not be able to take out more credit on your own behalf.
Credit taken out on someone else’s behalf is still seen as available credit to you, the co-signer. Therefore, your credit utilization (the amount of credit you’ve used versus what is available to you) could reflect a change if the type of credit you’ve co-signed on is considered revolving — like a credit card.
If the borrower keeps a high balance on the credit card, your credit utilization ratio could be considered high, impacting your credit score and how you look to a lender should you need to acquire a loan or credit card for yourself.
Again, there is no distinction made between the credit card habits you adhere to for those you are the primary user on and those that simply carry your name as the co-signer.
You can’t simply take your name off of a loan should the agreement go bad.
If the relationship between you and the primary borrower suddenly takes a turn for the worse, or they begin defaulting on payments, you can’t simply ask to be removed as the co-signer. This is precisely the reason banks agree to a loan – because they have a back-up plan in place should the borrower not be reliable.
There are a few ways that you can be removed from a co-signed loan, but most, if not all, require joint buy-in by the borrower – something that could be tricky if your relationship is no longer in good standing. These options include paying off the balance of the loan or refinancing the original loan (the borrower’s credit will have to be in better standing at this point).
Regardless of the way you go about it, it’s generally not easy or financially painless.
Is there any upside to co-signing a loan?
Perhaps the only upside to co-signing a loan is the potential to increase your credit score – if the borrower manages to make all payments in full and on time.
Knowing the risks involved, if you’re still committed to being a co-signer, make sure the borrower is fully prepared and financially able to take on the responsibility of the loan or credit card. On the flip side, it’s also good for you to be financially prepared to take on the payments should things not go as expected.