basics of co-signing a loan
generally take a cautious approach to first-time borrowers. Without a credit history
to go on, it's not unusual for them to require a co-signer before they hand over
A borrower who's been told he needs a co-signer
isn't necessarily considered a poor credit risk. Often, it's because there isn't
enough information to make an informed decision, which in banking circles means
president and CEO of the Birmingham, Ala., region of Colonial Bank, estimates
that only about 10 percent of borrowers need a co-signer to qualify for a loan.
Most often, the reason is that a person has little or no credit history upon which
to base a decision.
The most frequent scenario is a parent "trying to help out a child or
a college student," he says.
Co-signers typically will
have well-established credit to help the borrower qualify for the loan. But being
a co-signer isn't like giving a person a reference on a job application. It carries
a weighty responsibility and some potentially significant implications that need
to be understood before it's taken on.
That's because you're
not just vouching for the borrower's ability to repay the debt, you're promising
to pay it yourself if the borrower defaults.
Most people would
probably say, "That's fine. My (insert relative or friend) since third grade
has a good job, is very responsible and will make every single payment."
that may be absolutely true. It's also true that unanticipated things happen.
People lose their jobs, they get sick and they die unexpectedly. If, for whatever
reason, the borrower doesn't make the payments, you're on the hook.
If someone asks you to be a co-signer on a loan, you
need to consider the borrower's character and ability to make the payments, and
whether you could afford the debt if the borrower defaults, Naramore says.
main thing they need to understand is that they are signing that loan for a reason,"
Naramore says. "If the loan goes bad, they have to pay it back. That's what
everybody has to be prepared for. They need to look at this as if they were taking
out the loan themselves."
You should be especially wary
if the borrower asking you to co-sign is getting the loan from a finance company.
That means he's been rejected by traditional lenders and the loan carries a high
interest rate. Plus, the Federal Trade Commission reports that three out of four
co-signed loans with finance companies wind up being paid by the co-signer
FTC puts the situation into simple terms in its information on co-signing. You're
being asked to take a risk that a professional lender has decided not to take.
The risks are real and significant. The lender doesn't have
to exhaust every possible means to get the money from the borrower before he comes
"The bank or creditor can select which debtor
he wants to pursue," says Bob Doyle, a certified public accountant and personal
financial specialist in St. Petersburg, Fla. "He'll pick the one who is the
most likely to pay the quickest."
If the lender sues to
collect, you could get hit with attorneys' fees, and if he wins the suit, your
wages could be garnished. If you pledged property, such as your car or furniture,
you could lose it.
If you're thinking that a lender could
just repossess the item, think what that will do to your credit report. Plus,
if it's a car, it's been depreciating since the day it was driven off the lot.
It might not be worth as much as the balance of the loan.
addition, most people don't realize that the loan can affect their own ability
to get financing. Since a co-signer is legally obligated to pay the debt if the
borrower defaults, it counts the same as their own loans on a credit report and
is factored into their debt-to-earnings ratio.
one of those folks out there who may not have exemplary credit and in two years
realize you need to get a car and you have mortgage and credit card balances,
I don't think you'd qualify," Doyle says. "That's your risk."
Cohen sees what can happen with co-signed loans quite often. He's the regional
education coordinator for the Consumer Credit Counseling Service of Southern New
"There are people who end up with debts they
didn't know they were going to have," Cohen says. "They still have to
repay them, often by using our debt-repayment plan. I can't tell you how many
family relationships are stressed by that."
The FTC suggests two steps you can take to try to protect
First, ask the lender to put in writing that he
will notify you if the borrower doesn't make a payment. That should give you time
to handle the situation before it gets out of control.
ask if you can limit your responsibility to the value of the loan itself, and
not late charges or other collection fees.
If you do need to
free up some of your credit line after you've cosigned on a loan, it's possible
to get your name taken off the note, Naramore says.
you're three years into a five-year loan and the borrower has made every payment
and now has a very nice income, that's something we could do," he says.
a mortgage, it may require refinancing the loan, but if it takes tens of thousands
of dollars of potential debt off your credit report when you're shopping for a
mortgage of your own, it's worth the effort.
For all the cautionary
information, the experts say co-signing can be very helpful in the right circumstances.
Family members helped both Doyle and Cohen by co-signing for loans when they were
just getting started. It's not that uncommon, and it can be a great way to help
a person establish credit.
"I had a job and great salary
opportunities, but no one was going to loan a kid money to buy a used car,"
Doyle says. "I paid it off in 18 months. Boom, it was done. I had established
credit. Then people wanted to throw money at me."
the person who's been told you need a co-signer, Cohen suggests putting off a purchase
until you can save more or buying something less expensive.
perhaps if you go to the bank, they might consider giving you a loan for a smaller
amount, using nontraditional means of credit, such as showing them you have on-time
utility or rental payments. Then you might not need a co-signer You also could
do a passbook savings loan or a secured savings loan. That allows you as a consumer
to give them $1,000, they give you back $1,000, and you pay it off with interest.
Then no one is put into harm's way."
The bottom line,
Cohen says, is that you need to think carefully before taking out a loan that
requires a co-signer
"If you go to a reputable lender with
market-rate interest rates and you feel desperate, it's probably a signal you
shouldn't be getting this loan," he says. "That will take you into finance
companies that charge higher interest rates.
with poor credit will go to finance companies and have to get a co-signer We see
that all the time. There's nothing worse than being locked into a $12,000 balance
on a $5,000 car."