Getting married or buying a house are among life’s biggest commitments. Co-signing a loan is an equally important obligation — and one with potential risks that financial experts say both…
Getting married or buying a house are among life’s biggest commitments. Co-signing a loan is an equally important obligation — and one with potential risks that financial experts say both parties need to understand.
You may be asked to co-sign a loan or credit card application by your spouse, child or best friend, especially if your credit score outshines theirs. Co-signing for someone with a lower credit score or nascent credit profile can improve the odds of qualification or snag a lower interest rate.
But what sounds honorable — you helping someone get money for a new home or college tuition — can have consequences you may not expect. Here are three risks to consider before you co-sign, and how to protect your finances if you do.
1. Your credit is on the line
When you co-sign a loan, you risk wrecking your own credit profile. Both the loan and payment history show up on your credit report as well as the borrower’s.
In the short term, you’ll see a temporary hit to your credit score, says Bruce McClary, spokesperson for the National Foundation for Credit Counseling. The lender’s hard pull on your credit before approving the loan will ding your score, he says, and so will the increase in your overall debt load.
Longer term, you may be rejected for credit when you want it. A potential creditor will factor in the co-signed loan to calculate your total debt levels and may decide it’s too risky to extend you further credit. Any missed payments by the borrower could also negatively affect your score.
Check your credit report regularly after co-signing to keep an eye on your finances, says McClary.
In addition, get access to the loan account and track payments, says Byrke Sestok, a certified financial planner at New York-based Rightirement Wealth Partners.
“It’s not a trust issue — problems happen,” Sestok says. “If you find out in the first month that someone is having a problem [paying back the loan], you can do something about it.”
2. You could be sued by the lender
In some states, if the lender does not receive payments, it can try collecting money from the co-signer before going after the primary borrower, according to the Federal Trade Commission.
To get to that stage, the borrower would likely have missed several payments, and the debt would already have started to affect your credit. Lenders are likely to consider legal action when the debt is between 90 days and 180 days past due.
If the worst happens and you are sued, you’re responsible as the co-signer for all costs, including late fees and attorney’s fees.
Before you sign on the dotted line, clearly understand what you’re getting into, says Urmi Mukherjee, a Kansas City-based financial counselor at Apprisen, a nonprofit credit counseling agency.
Ask the lender what your rights and responsibilities are and how you’ll be notified if payment issues come up, she says.
3. Your relationship could be ruined
The borrower may start out making full, on-time payments toward the loan or credit card with all good intentions. But financial and personal situations change.
Children who run into trouble with payments toward a co-signed credit card or car loan may hide the shortfall from their parents until the situation worsens, ruining trust in the relationship.
Couples going through a divorce often have to deal with the financial consequences of a co-signed car or mortgage, Mukherjee says. In those cases, it may be tough to persuade one spouse to pay his or her share, especially if the spouse has moved out of the house or given up the car.
To plan for such occurrences, establish an arrangement between co-signer and borrower upfront and in writing that spells out expectations for each person, says McClary. Your private agreement will help smooth out mismatched expectations, he says.