Your child needs $10,000 to make up a college tuition shortfall. Your single-mom sister wants to buy a house with a yard for her kids. Your nephew has a brilliant idea for an exciting new business he says is guaranteed to make millions.
At some point, a family member (or a friend) may approach you to co-sign a loan to make a dream come true.
On the surface, agreeing to be a co-signer seems like a helpful, low-risk — and even benign — gesture of support.
But it’s far from that.
The bottom line is that you are left holding the bag for the entire loan — no matter what — if the person should happen to default, warns Jason Hull, owner of Hull Financial Planning in Charlottesville, Virginia.
“It doesn’t matter if the person who asked you to co-sign has a sob story that would hit the top of the country charts if it was made into a song. The bank won’t care,” says Hull.
So is there ever a reason you should sign on the dotted line to vouch for kin or comrades on a loan?
Absolutely not, agree the experts. And here’s why.
When you co-sign, you are promising to pay the loan in the event the borrower cannot. In other words, you agree to be on the hook for someone else’s debt.
“While your heart may be in the right place to help a loved one get the credit he or she needs, you are banking on this person to be responsible in repaying this loan,” says Leslie Tayne, a debt resolution attorney in Melville, New York.
You are also taking on the full responsibility of inheriting the debt should that person become unable to pay or act irresponsibly in repaying the loan. “The fate of your credit standing, credibility and finances are essentially being put in his or her hands,” warns Tayne.
This kind of trust can end badly and have life-altering financial consequences for a co-signer.
If the loan is paid off on time and in full, no problem, right?
“Co-signing can be the kiss of death for your credit report,” says Michelle Black, co-owner of the Home Ownership Program for Everyone, or Hope, a credit education and restoration program based in Fort Mill, South Carolina.
Black says that even if the loan is paid on time, the potential new debt you have taken on will most likely drop your credit scores because 30 percent of your score is based on the amount of debt you carry. Co-signing also will increase your debt-to-income ratio, making it harder for you to qualify for loans you may need, such as for a mortgage or a new car, she says.
“Co-signing for someone else’s loan is like playing Russian roulette with your credit scores,” says Black. “It is dangerous and most certainly costs you in the long run when you are turned down for a loan you personally need or are forced to pay higher interest rates.”
And that’s the best-case scenario. The worst case is when your family member or friend defaults on the loan.
If your friend or family member defaults on the debt, you, as the co-signer, will not only suffer bad credit ramifications, but you also will be obligated to pay the money back.
“If the person you are co-signing the loan with defaults, you run the risk of possibly having your bank account frozen, wages garnished and credit score lowered,” says Tayne.
Reeta Wolfsohn, president of the Center for Financial Social Work in Asheville, North Carolina, recalls many instances of clients’ lives being forever altered because of co-signing gone wrong.
For example, a wife who co-signed her (now) ex-husband’s school loans had her paycheck garnished years later in order to pay the debts. A woman who co-signed her sister’s mortgage couldn’t buy a house for herself because her FICO credit score had plummeted after the sister stopped paying the mortgage.
“Co-signing isn’t meant to be a thoughtful gesture; it is meant to be a responsible decision,” says Wolfsohn. “It is a serious long-term commitment to take on someone else’s financial obligation if they stop doing so, which happens very frequently.”
“Nothing comes between friends or family like borrowed money,” says Hull. “Nobody wins.”
The borrower feels guilty about it. You feel uncomfortable asking the borrower about the loan payments. And that’s when things are going well. If the person for whom you co-signed fails to make good on the debt, your relationship can go south very quickly, Hull says.
“Relationships can be compromised and sometimes severed,” adds Tayne.
Bad feelings can get complicated if it is not brazen irresponsibility — but rather unforeseen circumstances such as a job loss — that keeps a borrower from paying back a loan. And remember that you also could be left with the burden of the debt if the borrower becomes sick — or dies.
Co-signing, concludes Hull, is a financial agreement with no upside. “You are on the hook for all of the potentially negative outcomes,” he says, “but you get none of the benefits.”
If your pal or a family member does come to you with a sob story fit for a song that only your signature on a loan can fix, don’t let your emotions and fondness for the person dictate your decision.
Instead, politely decline and say you don’t want to spoil the relationship, advises Coleen Pantalone, a personal finance expert and an associate dean of the College of Business Administration at Northeastern University in Boston.
Ultimately, she says, by saying “no” you are doing the other person a favor.
“If someone is having trouble managing their money, you are abetting that bad habit by helping them,” says Pantalone.
If, for whatever reason, you ultimately agree to be a co-signer on a loan, chalk it up as a gift — you’ll be less disappointed if things go bad, says Pantalone. Better yet, assume right from the moment you co-sign that you will have to pay the loan back yourself. “Make sure you can afford to lose the whole amount without affecting your financial well-being,” she says.