By Rachel Puryear
There’s an old saying that if you loan money to a friend, you should be prepared to lose both your money and the friendship. That is often true, but not always.
The same principle, however, could be applied to cosigning. Cosigning is where someone (a “cosigner”) agrees to be responsible for someone else’s (the “primary borrower”‘s) loan or other financial obligation. In short, the cosigner formally agrees that if the primary borrower doesn’t pay, the cosigner will cover it.
If others around you generally see you as reliable, then someone has likely asked you to cosign a financial obligation for them at some point. Perhaps if this happens, you might like to help – but are concerned about the negative consequences of doing so.
Maybe a relative wants to rent their first apartment, but doesn’t have an established rental history; and having a cosigner to a lease would make them more appealing to landlords. Maybe a good friend was down and out for a while, but subsequently recovered; and now needs a car to get to their new job, but still has poor credit.
On the one hand, cosigning could give your loved one a financial benefit which would be much less accessible to them on their own. At the same time, even if you believe that your loved one intends to make good on the obligation; something could go wrong, and it could have a seriously negative impact your own finances.
It can therefore be a difficult and risky decision to make. Here’s what you need to know before you cosign:
Cosigning Means That You Share All the Risks, But Receive None of the Benefits:
A cosigner receives none of the benefits of the financial transaction – they have no access to the loan proceeds, they are not on title to any property, and so forth. However, they are fully responsible for the financial obligation, if the primary borrower does not pay.
The lender/creditor does not necessarily have to exhaust every effort to collect from the primary borrower, either before turning to the cosigner for payment. If you have better credit and a more established financial situation than the primary borrower, the lender/creditor will likely see you as deeper pockets to go after.
A cosigner will not have an easy time getting out of the obligation, either – if they can get out at all. Usually, to later get a cosigner off the hook; the primary borrower must show that they have the credit and the ability to qualify on their own; so that they no longer need a cosigner. In that event, the lender/creditor will still usually need to approve removing a cosigner from a loan or financial obligation.
Often Times, it’s Actually Cheaper to Just Give the Money Outright:
If you balk at this idea, or think you cannot afford to do this, then you’re not in a position to be cosigner. And if that’s the case, it’s ok. The important thing is to know that before going further.
Here’s why: If the primary borrower defaults, you will be on the hook for the entire amount they owe, anyway. In addition to that, you’ll also have to pay interest, late fees, collection fees, and other costs arising out of the default. Your credit score will take a hit, which could cost you. This is why it’s often cheaper to just give the money as a gift. If you don’t want to do that, then don’t cosign – because you could end up losing the same amount of money, plus a lot more.
If You Do Decide to Cosign:
If, after knowing the risks, you decide that you still want to help your loved one by cosigning; they are quite lucky to have you on their side. Here are some things you can do to mitigate (even though you never eliminate) the risks to yourself:
- Pay attention to what the loan documents (or lease, or contract) say about notice requirements to you, as the cosigner. If the primary borrower defaults and you don’t find out about that until it’s well into the collections process, it will cost you more to fix the situation than it would had you known much earlier that there was a problem. If possible, see if the lender/creditor will agree to copy you in on communications with the primary borrower.
- Keep in touch with the primary borrower. Hopefully, they are also proactive about doing so with you – if you’re doing this for them, they should be. There is nothing wrong with wanting to check in regularly with the primary borrower about the situation. If there seems to be trouble ahead, and they might not be able to keep up with payments, you want to know this as soon as possible – in order to give yourself the most recourse options.
- Distinguish between necessities and nice-to-haves. If someone asks you to cosign a loan for a car adequate to get them to work and back, that’s one thing. If they could get an adequate car themselves, but instead want you to put your credit on the line so they can have a much fancier one, that’s another thing. A measure as drastic as cosigning should be reserved only for obtaining true necessities that will open up important opportunities, not for frivolous luxuries. If your loved one wants frivolous luxuries, that’s fine, but they can work for and earn it themselves.
A Tip for Establishing New Credit:
If a loved one simply does not have much credit history, that does not necessarily mean they are likely to default on obligations. It just means they have not opened many formal lines of credit. In this case, there are ways for them to build credit. If you want to, you can help them get started.
For better or for worse, building credit works by taking on debt and then paying it back.
By putting up about $500.00, a person without credit can get a secured credit card. They can make charges on it each month, and then pay off the balance each month. After a while, their credit score will have likely improved enough to qualify them for an unsecured credit card – at which point they can close the secured one, and get that money back. With an improved credit score, they will likely also qualify for other credit opportunities.
Thank you, dear readers, for reading, following, and sharing. Here’s to knowing what you’re getting into before you sign.
If there is something you would like to see addressed on this blog, please reach out to me here to ask. If you want to see more content like this and you don’t already subscribe, click here to get the Free Range Life and Work newsletter 2x a month!