Couple discussing finances
Bruce Ayres/Getty Images

Ever been asked to be a co-signer for a car? On paper, it sounds like you might be helping someone out. Maybe your spouse needs help with that vehicle purchase or, perhaps, it’s your child’s first car. Unfortunately, there are often more reasons not to co-sign than there are exceptions.

There’s a lot on the line, especially when it’s a personal loan with co-signer (namely you) to help move things along. While you might think you’re helping someone, how that someone conducts themselves when it comes time to settle up with the lender can reflect negatively on you.

Here are 10 reasons why you should think twice before co-signing a loan.

1. Co-signing a loan is high risk, low reward

You might co-sign on a loan for a car you’re not driving or a mortgage loan for a house you don’t live in, but that doesn’t change your liability. Your credit score benefits only slightly from the monthly payments. And since you qualified as a co-signer because of your good credit, you don’t necessarily need more credit lines. By co-signing a loan, you take on all the risk if the loan is not repaid but may see only a modest improvement to your credit score.

2. The lender will sue you first if payments are not made

While it might seem strange that the lender would look to you, think about it from their perspective. It’s true that you may not have borrowed the money but, by co-signing a loan, you enabled the person who defaulted to get the loan in the first place. Whether you’re a co-signer for a car or a mortgage, it takes two to tango and the lender can try to sue you if payments are not made.

3. The person you help will be happy, but you will have a lot to lose

Your signature might make the other person happy because you helped him or her out. But that excitement does not last forever. “Buyer’s remorse” can set in.

Even worse, the person who you helped most likely has bad credit. So he or she does not care whether another negative mark appears on his or her credit report. Needless to say, you have much more to lose.

4. Co-signing a loan can destroy friendships and families

Not surprising when you think about all the time and energy you could spend ensuring the other party keeps up with their payments. This due diligence can take its toll on a friendship and, as the co-signer, your desire not to suffer any negative impacts could be construed as mistrust. And, if they fail to make any payments, that can have a profound impact on your finances and further fuel the fires.

Remember, one missed or late payment could mean a black mark on your credit. You may not be very willing to forgive or forget, and that can definitely destroy a friendship or sever family ties.

5. You are 100 percent liable on a loan that could be a significant amount

Co-signing a loan makes you liable to pay for the entire balance should the guilty party fail to pay. And, unfortunately, most lenders are not interested in having you pay half of the loan. This means that you’ll have to work it out with the other party or get stuck paying off the entire balance.

6. You could face tax consequences from co-signing a loan if the debt is settled

The lender might not want to go through the trouble of suing you and agree to settle the balance owed. That will mean you could have tax liability for the difference. Meaning if you owe $10,000 and settle for $4,000, you may have to report the other $6,000 as “debt forgiveness income” on your tax returns.

Also, settling on the account will leave a negative mark on your credit report. The account does not state “paid as agreed,” but rather, “settled.” Your score suffers because of that new mark.

7. Co-signing a loan could make approval of a loan you might need impossible

Before co-signing a loan, think ahead because you might just need a loan yourself one day. Take, for example, a co-signer for a car. The co-signer in this situation is actually signing for his wife who has less-than-stellar credit. Unfortunately, by doing this, he has found himself denied for an application on a loan of his own because he “has too much credit in his name.”

When you’re thinking about co-signing a loan, it’s wise to bear in mind that helping someone out might hinder your own opportunities.

8. You’ll be making that payment if your co-signer defaults

Be prepared to make the loan payment. I would tell you to take the monthly payment and put it into a savings account and then keep it there. Once you have 12 monthly payments saved, you can stop saving. Hopefully, you never have to pay more than 12 payments on the loan, but be prepared for the worst-case scenario that you have to make the payment.

9. You may need to sue the other responsible party if payments are not made and you get sued

No one likes the idea of suing their friends and family, which is another reason why co-signing a loan can be a bad idea. However, sometimes the situation can arise and if you’re being sued because of a co-signer’s failure to pay, you may need to bring the responsible party into the lawsuit. In some cases, it may be the only way to get them to help with the monthly payment.

This can get very messy, as you can imagine. Not only are relationships being tested but, in the eyes of the law, you are just as responsible for your co-signer’s behavior as they are. As the co-signer for a car, boat, etc. you could be sued and, if that happens, you might be left with the unhappy duty of suing the party responsible.

If you are not able to bring the other party into the lawsuit, you can sue them later on to contribute to your monthly payment. Unfortunately, getting a judgment against the other party is much easier than getting him or her to pay. Sometimes, you may need to hire a debt collection attorney or law firm to assist you.

10. You have to be organized enough to keep track of the payments when co-signing a loan

Think it’s hard enough to keep track of all your bills and payments? Well, if you co-sign, you’ll also need to keep track of someone else’s bills and payments. This will mean checking each month either online or by calling customer service to make sure the payment has been made. You can’t blindly believe all payments will be made. Don’t wait until some collector calls you saying payments have not been made in six months. By then, your credit will already have been negatively impacted.

Be wary when co-signing a loan

Co-signing a loan can seem like you’re helping out a friend who doesn’t quite have the credit rating you do. And, in some cases, it’s perfectly reasonable to co-sign. Just make sure you consider all the risks and co-sign only for somebody you trust. Be sure and have clear lines of communication. Don’t go into this thinking you’re a co-signer for a car only to find out they’re taking out a mortgage on a mansion. And don’t let dialogue break down or you could find yourself staring down a black mark on your credit and an indelible blot on your relationship.

CO-SIGNER AND CO-BORROWER: Learn the difference and avoid making a financial blunder.