Smart About Money: Should I co-sign a loan?

“Should I co-sign a loan for a family member or friend?” is a question bankers hear all the time. It’s a common request and you may choose to co-sign. But before agreeing, you need to be absolutely clear about the risks you’re taking when you co-sign.

Here’s the reality: Let’s say that the person asking you to co-sign a loan had applied at a bank and was turned down. That means an objective lender who wants to write loans took a look at that applicant’s credit and ability to repay. They saw a history of non-payment or lack of sufficient income to repay the loan or both. So the bank would not loan to them.

Being turned down by a bank is a huge red flag. As a general rule of thumb, if someone who’s now asking you to co-sign a loan for them got turned down by a bank (or any other regular lender, like a car dealer ), you should almost certainly say no too. Especially if the person is an adult who has well-known problems managing their finances.

The person asking you might get mad if you say no. They will almost certainly be disappointed. But there are significant and vitally important reasons to turn down loan co-sign requests, including:

  • When you co-sign a loan, it’s a very real financial obligation. You become the co-borrower with that person. However, you aren’t the co-owner of whatever they’re buying. They can stop making the car payments or mortgage payments and you won’t have any ability to get them to sell that asset and pay off the loan. You will have to make the payments for their car or house. That’s what you’re agreeing to when you co-sign.
  • Second, being a co-signer affects how much you can borrow in your own name. It will count against your debt-to-income ratios and possibly keep you from being able to get a mortgage or a home equity line of credit.
  • Third, your friend or family member may stop paying the loan and not tell you. Many times, you’ll only find out when the delinquency starts negatively affecting your credit report which will absolutely hurt both your own ability to borrow and the interest rates you’ll pay.

According to The Atlantic, “If you think they really need the money, just give them the money. What? You can’t afford to do that? Well, given the default rate of primary borrowers, that is what you’re doing when you co-sign a loan – with the additional cost of origination fees, interest payments, collection fees, a black mark on your credit report and, probably, a destroyed relationship.”

Hard to put it more clearly than that.

On careful consideration, you may ultimately decide that in a particular situation you do want to co-sign a loan.

Or maybe instead of co-signing, you decide to take out a loan and get the other person to re-pay you. That does remove many of the problems associated with co-signing.

Of course, it is also 100% okay to tell someone who wants you to co-sign a loan that you just can’t make a financial commitment that could all too easily turn their problems into your problems. That’s the truth and, if you really don’t want to co-sign, that’s all you have to say.

The bright side if you decide not to co-sign? Every bank lender has had people come in later and thank them for saying no. Refusing to co-sign protects you and could easily ultimately be a good thing for your family member or friend too.

(Should a parent co-sign a car loan for a child? That’s a different situation and a topic we’ll cover in a future column.)

Nick Maffeo is the President & CEO of Canton Co-operative Bank in Canton. “Smart About Money” is a regular column he writes for the Canton Citizen. Have a financial question you’d like to ask? Email to info@cantoncoopbank.com.

 

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