Compare the pros and cons of cosigning a loan, and learn some alternatives you could offer.

Some say that friends and money should never mix because the strain of money issues can ruin a friendship. Is it those same people who say they would do anything for a friend? People who seek loan cosigners usually have no or bad credit, so they can’t get the loan or the interest rate they want. Being asked to cosign a loan is not the same as a request to borrow money, or is it?

What Cosigning Means

When you cosign a loan, you agree to take on the responsibility of that financial contract if the signer defaults. Cosigning a car loan, for example, means you would have to make the payments if your friend or family member fails to fulfill their obligation to pay back the loan. Plus, you would also be responsible for late fees or other charges. The only thing you would not be accountable for is driving the car. As a cosigner on a car loan, you have no rights to the vehicle.

How Cosigning Can Affect Your Credit

If you have good spending habits, cosigning a loan might be an opportunity to teach your habits to others.

The reason your loved one might ask you to cosign a loan is because you have strong credit. Cosigning a loan has the same effect on your credit as if you were the only signer on that loan. The total amount of the loan becomes part of your debt load, increasing your debt-to-income (DTI) ratio. If the loan is paid back according to the terms, your credit rating will not suffer. But until it is repaid, your ability to borrow more for your own purposes could be restricted.

Any late payments on a loan you cosign will be reflected on your credit report, and your rating will go down. As the cosigner on the loan, you will not receive the monthly statements or late payment notices, so you might not realize your credit is taking a hit, at first.

Why Cosigning May Be a Good Idea

Being asked to cosign a loan is a compliment to your strong credit. It may be a way for you to support or repay a friend or loved one for help they rendered to you at an earlier time in your life. As long as you can be sure the loan is repaid promptly, your good deed will help your friend or family member build or repair their credit and may strengthen your relationship. When the loan is repaid, according to terms or early, your credit may benefit.

If you have good spending habits, cosigning a loan might be an opportunity to teach your habits to others. You could help the borrower create a reasonable budget to be sure the loan payments are made on time. By cosigning, you will help the borrower get a better interest rate, which will save them money, and the monthly payments will fit into their budget more easily. Checking on the loan regularly will hold your friend or family member accountable.

Why Cosigning May NOT be a Good Idea

You are taking a chance, and many things that you have no control over might go wrong when you cosign for a car loan.

• What happens if you cosign a car loan for your friend, and they end up in a car accident and total the vehicle? Will they pay back the loan even though they have no car to drive?

• What if you cosign a loan for your significant other, but the two of you break up before it is paid back? Making payments on a car you do not own will certainly add to the pain of the breakup.

• What if you cosign a loan for your kid who wants to buy a fancy car to celebrate a new job? If your kid loses that job, and you can’t afford to pay for the car, your credit could be ruined. You may not be able to cosign the next time.

It is a good idea to consider all the possibilities before cosigning a loan. The worst-case social and emotional consequences could negatively affect your credit and your relationship.

How to Get Out of Cosigning a Loan

The need for a cosigner shows that your friend or relative has bad or no credit. Bad credit can be a sign of poor financial planning or spending habits. If you decide not to cosign, here are some things to point out in explaining your decision:

• Cosigning would make me financially responsible for a debt I cannot afford. If I cosign on your loan, my DTI ratio will be too high for me to borrow money for the house I’m planning to buy.

• I turned down your cousin’s request for me to cosign a loan last year. It wouldn’t be fair if I cosigned your loan now.

• I’ve worked hard to attain the high credit rating required for my job. I cannot put that in jeopardy by adding unsecured debt.

Remember that someone else’s poor financial decisions are not your responsibility – unless you cosign a loan for them.

Alternatives to Cosigning a Loan

You don’t need to sacrifice a relationship by refusing to be a cosigner. There are some alternative ways you could help your credit-challenged friend or family member buy a car.

You may want to loan your friend some money for the down payment. With a bigger down payment, the interest rate would be lower, and the overall cost of the loan might be easier for your friend to qualify for. Loaning your friend cash, if you have it, gives you more control over your financial position.

Another alternative to cosigning a loan for a friend is helping your friend make better financial decisions. With a little coaching from you, your friend may be able to improve their credit, increase their savings, and choose a car they can afford. By asking you to cosign, your friend opened the door to these financial conversations. Help your friend out with good advice and information about how you achieved a strong credit rating.

0