What to Know Before Cosigning a Loan

If you are thinking about cosigning a loan, then there a few things that you should educate yourself first. I have cosigned a few loans in my lifetime. Each of those experiences worked out perfectly fine, which I attribute to the research, in-depth thought process, and boundary-setting that I did before I agreed to do it. I have also turned down a few people who asked me about cosigning a loan. Sometimes it’s just not the financially smart thing to do.

Why Someone Asks You To Cosign a Loan

People need someone to cosign a loan when they can’t qualify to get the loan themselves. For example, my mom cosigned a loan for me on the first car that I purchased from a dealership. I was still in my teens, so I hadn’t established any of my own credit. I couldn’t qualify for the loan on my own. We had an agreement that I would make all of the payments if she helped me to get the loan. That’s a pretty common scenario.

However, sometimes someone asks about cosigning a loan for them because they have bad credit. Bad credit is different from no credit. Bad credit means that the person already has a history of late payment, taking out too much credit, or otherwise making financial decisions that have negatively impacted their own credit. When you agree to cosign a loan for that person, you take on the risk that they aren’t going to be able to make the payments.

Cosigning a Loan Impacts Your Credit

When you cosign a loan, that debt goes on to the borrower’s credit report, but it also goes on your own credit report. If you cosign a loan, then it probably means that you have established good credit for yourself. You may not want to take the risk of jeopardizing that credit. That’s exactly what will happen if the person doesn’t pay back the loan in a timely manner. Every time that they make a late payment, that gets reflected as a late payment on your own credit report.

You Don’t See The Bills Until It’s Too Late

If you’re a parent who is cosigning a loan for a teenager, then you might have access to all of the bills. Therefore, you could easily see if payments are going to be late, and decide what to do accordingly in order to save your own credit. However, the bills don’t ever come directly to you. If you cosign a loan for another adult – such as a friend or adult sibling – then they could go months without paying the bill and you might never even know.

If you pull your own credit report regularly, then you might see delayed payments relatively early on. Otherwise, you might not know that anything is wrong until bill collectors start calling. They don’t call the cosigner until they’ve given up on the borrower, so by then the account is typically quite delinquent. As a result, your own credit suffers. Even if you pay off the debt immediately, the late payments can stay on your credit report for a long time.

Alternatives To Cosigning a Loan

If you want to help someone out, but you don’t think cosigning a loan for them is a smart choice, then you have a few options. If you have access to the cash in your own accounts, then you can choose to make a private loan to the person using your own money. Create a contract and set up structured payments. Of course, you run the risk that they won’t pay you back (just as you run the risk that they won’t pay off a debt that you cosign for) but at least it doesn’t jeopardize your own credit.

If you don’t have the money to make the loan outright, then you might consider taking a loan in your own name. You would pay off that loan, giving you control to make sure that the debt is paid. Again, though, you run the risk that the individual doesn’t pay you back. Therefore, it’s important to think really carefully about the following things:

  • Can you trust the borrower to pay you or the lender back in a timely manner?
  • Do you have the financial ability to pay the loan if the borrower doesn’t come through?
  • How is this loan going to impact your relationship if things don’t go as planned?

Oftentimes, it’s better to just say no to cosigning a loan. It may put a small strain on your relationship. However, it’s not as big of a strain as it would be if the person ruined your credit by failure to repay a loan that you signed on.

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