APR 13, 2015
What would you do if a friend or family member asked you to cosign a loan? Before you answer, make sure you understand what your obligations are.
When you agree to cosign for someone else’s debt, you are essentially guaranteeing payment if that person defaults. You are being asked to take a risk that a professional lender will not take. Think about it: the lender would not need a cosigner if the borrower were a good risk.
Cosigning Means You’re Financially Responsible – Consider the Risks
The obligations associated with cosigning a loan can be more than people expect. So before you put your autograph on the dotted line agreeing to cosign a loan, the Federal Trade Commission requires the creditor to give you information explaining your commitment. It states:
“You are being asked to guarantee this debt. Think carefully before you do. If the borrower doesn’t pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility. You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount. The creditor can collect this debt from you without first trying to collect from the borrower. The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become part of your credit record. This notice is not the contract that makes you liable for the debt.”
If you are thinking about cosigning you should consider the following:
When Is It Worthwhile to Cosign?
When it’s important to you that the borrower get credit, and you have good reason to believe the borrower will repay the debt, it can be worthwhile to cosign for a loan or credit card.
Parents often cosign for their adult children who have ample income to qualify individually, but lack a solid credit or employment history. By cosigning, parents help their children receive a loan and establish credit in their own name.
Similarly, sometimes a spouse or family member will cosign for a small loan or credit line to help an individual establish or rebuild credit in their own name.
Although the statistics on cosigning support that it’s a relatively high risk, that’s not always the case. There have been many successful situations where cosigning served the interests of all parties. Statistically, though, the risk often outweighs the benefit. Some studies show that three out of four cosigners end up having to repay the loan for the original borrower, so it’s important to take steps to protect yourself if you do cosign.
If you are worried about some of the risks that cosigning carries, you may be able to negotiate specific terms of your obligation. For example, you might want to have your liability limited to paying the principal balance on the loan, but not late charges, court costs, or attorney’s fees. In this case, ask the lender to include a statement in the contract like: “The cosigner will be responsible only for the principal balance on this loan at the time of default.”
If You Need a Cosigner
If you’re in need of someone to cosign a loan for you, talk with family or friends and explain to them that they’ll be helping you to reestablish your credit. Understand that cosigning is a big step for the person agreeing to sign for you, so make sure you make them feel as comfortable as possible about cosigning for you. Show them you’ll be able to repay the loan. Remember that if you fail to repay the debt and the cosigner has to step in to repay it but can’t afford it, then you both will have damaged credit histories. Therefore, the credit you obtain will carry a double weight of responsibility – your obligation to the lender to repay what you borrow and your obligation to your cosigner to live up to the investment they’re making in you.
Whatever your involvement in a cosigned credit transaction, remember that cosigning means extra obligations for everyone involved and consider your decision carefully.