Co-Signing A Loan? It’s A Big Risk, So Know the Rules


Should you co-sign a loan for a friend, family member, or business partner?

The short answer is “no”, but there’s a lot more to the issue than simple one-word answers. In many cases, you’re stuck between a rock and hard place and want to help out (especially for your child’s college loan.)

Before you make any moves, first, a reality check.

According to the Federal Trade Commission (FTC), recent studies have shown that 75% of all defaulting loans with co-signers are ultimately repaid by the co-signer, and not the original borrower In addition, the FTC says that creditors will pursue the signee with the stronger credit first if the loan falls into delinquency – a direct threat to that strong credit score you’ve spent years building.

Beyond that alarming statistic, the biggest risk is that something bad could happen to the primary beneficiary of the student loan, and you’ll be left with the bill. If the primary borrower can’t repay the loan, you, as the co-signor, will be held responsible.

In my research on the topic, I talked to a family where a 25-year-old New Jersey man, very unfortunately, passed away. He owed $85,000 on a student loan, which both his parents had co-signed. It wasn’t long after the death that the private lender went after the parents for money.

The parents balked, saying the lender didn’t make it clear they’d be responsible if their son couldn’t repay his loan. But the lender didn’t want to hear it, and with the legal system in full support, went after the parents for the loan money.

Still, it’s tough to say no to a loved one asking for a co-sign. So if you can’t, here’s what you should understand about the risks and rewards of allowing co-signing “piggybacking” on your good credit:

Smarten up  

Right out of the box, the co-signer (that’s you) needs to know that they are equally responsible for repayment of the loan, and that all activity will be reflected on their credit report. Therefore, if the person you’ve co-signed for has agreed to make the monthly payments, but doesn’t, not only will the lender expect you to fulfill the obligation, but your credit report will reflect the negative activity.

Exercise leverage  

If you do elect to co-sign a loan, make the rules. As the loan partner with the stronger credit score, you have the most to lose in a co-signing arrangement. So use that leverage to lay down some basic rules of the road. For example, the authorized user (your co-signee) has charging privileges on the account to which he or she has been added, but with no responsibility for payment. Check that privilege, since you are responsible for the charges incurred if the authorized user reneges on holding up their end of the bargain. Thus, make sure your co-signee knows, going in, what the financial limits are on any loan arrangement –and get it in writing.

Jawbone the issue until you get what you want  

Before you sign on the dotted line, have a candid conversation with your co-signee. Make sure he or she knows that the borrower tends to be the one who benefits from co-signing, and that benefit comes with big responsibility. Also know that, for any reason the borrower defaults, you bear the risk of having your bank accounts frozen, wages garnished, and credit score lowered. Also, if the borrower is unable to pay due to illness, handicap or death, it is the co-signer who inherits the responsibly for the loan. When both parties know the risks involved, you’ve got a much better chance of getting the loan paid off without your help.

Have a “way out”

If you do decide to co-sign a loan, make sure you understand the terms and what the process is for getting yourself removed from the loan, if need be. Check with the lender to create an exit strategy (usually that can be allowed if the loan is well on its way to being paid without your help.)

Above all else, go into a co-signing deal with your eyes wide open, and your options wide open as well. Co-signing a loan is a serious matter, and your good credit is on the line. Keep that thought in mind when you’re pulled into a personal loan that’s not of your making.

Posted in Finance
Learn how it works

Questions about credit repair?

Chat with an expert: 1-800-255-0263

Facebook Twitter LinkedIn