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Think Before You Choose to Cosign for a Loan

written by: Kantha Wijeratne•edited by: Laurie Patsalides•updated: 4/11/2011

Wondering if you should cosign for a loan? Cosigning a loan involves sharing equal liability with a primary borrower for a loan or mortgage; a commitment that requires careful thinking. Consider the risks and liabilities related to cosigning a loan before taking on this responsibility.

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    Risks Related to Cosigning

    Certain credit and loan situations call for a cosigner, someone who will share equal credit liability for payments to secure a loan. Many people do not consider the risks involved before agreeing to cosign a loan for someone. Unfortunately, this can lead to trouble for them later.

    Not every cosigning decision is fraught with risk. If you and your spouse have good credit ratings and both of you are cosigning a mortgage, the risk can be considered minimal. Cosigning will help you both meet mutually agreed financial goals. What if you consent to cosign a loan with a child or friend who has no credit rating? Provided your child or friend is reliable in meeting commitments and has a steady income, then your risk of actually having to meet your obligations as a cosigner may be little. However, there are other situations when cosigning a loan can land you in hot water and sour your relationship with the primary borrower.

    For instance, a lender can refuse to grant a loan to a borrower unless it is co-signed. If you agree to cosign such a loan, you are taking on the default risk that the lender is not prepared to take. Is this because the borrower has a poor credit rating arising from nonpayment or late payment of previous loans? If you intend to cosign a loan, it is good to check whether the primary borrower has obtained any cosigned loans previously and how well he has met his payment obligations on such loans.

    Remember that by agreeing to cosign a loan, you jeopardize your own credit standing. How is this possible? Cosigning implies that you have the resources to pay not only the full amount due from the primary borrower but also late payment fees and collection charges. If the primary borrower defaults on payments, lenders in some states have the right to then request you to pay all dues. They can also use collection methods such as suing you or garnishing your earnings as if you were in default. If you do not pay up, this will adversely affect your credit rating. Cosign only if you can afford to meet all payments. By cosigning you also limit your own chances of applying for credit as this loan would appear as a facility granted to you in your credit report.

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    Precautions to Take When Cosigning a Loan

    There are some precautions you can take before you decide to cosign a loan. Get a copy of the Truth in Lending Disclosure statement from the borrower to understand the terms and conditions relating to the loan. If the loan involves a purchase, check what is covered by the product warranty. Ask whether the primary borrower has looked into other ways of financing the purchase. Most importantly, understand what rights you have as a cosigner before you commit yourself. You can also check the laws of your State for any special rights that are available to cosigners.

    Another option that may be considered is to avoid acting as a cosigner at all. Is it possible to provide an outright gift of money to help with the purchase or enter in to a private agreement with the borrower rather than agreeing to cosign?

    Be careful about pledging your personal assets to secure a loan as you risk losing them in the event of a default situation. You can also safeguard yourself by requesting a written agreement from the borrower to inform you if the borrower defaults on a payment. This way, you can discuss this with the borrower and work out a solution before the situation worsens.

    In conclusion, the risks attached to cosigning a loan far outweigh its benefits. Illness, job loss or other adverse situation of the borrower can result in your having to honor all loan payment as the cosigner. Avoid sleepless nights and the stress of taking on a responsibility that can impact your financial security. Think carefully about these cosigning risks before you agree to share responsibility for any loan.

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    Resources:

    1.Federal Trade Commission. “Facts for Consumers.” http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre06.shtm

    2.Harelik, Justin. ”Co-signing a loan can be calamitous”. www.Bankrate.com

    3. Rowland, Mary. “Why you should never co-sign a loan”. http://articles.moneycentral.msn.com/Banking/YourCreditRating/WhyYouShouldNeverCoSignALoan.aspx