- 1 Things to Consider Before You Co-Sign an Auto Loan
- 2 Why parents should never cosign a student loan
- 3 Co-signing a loan can strain relationships
- 4 Co-signing a loan is dangerous to your financial health
- 5 Risks of Co-Signing or Co-Borrowing on a Loan
- 6 Can I Cosign for a Home Equity Loan If My Name Is Not on the Deed?
- 7 What to Know Before Cosigning a Student Loan
Things to Consider Before You Co-Sign an Auto Loan
A co-signer is someone who agrees to take on the responsibility of paying the loan if the original borrower is unable to pay.
They are legally responsible for the loan and will have their credit affected, wages garnished, and possibly sued if the loan is not paid off.
Co-signing a loan is a huge responsibility so you need to be aware of the consequences.
Never Co-Sign if Borrower Has Bad Credit
A co-signer should only be used in cases where the borrower has a lack of credit history, never if they have bad credit.
There's a reason why their credit is bad - they failed to pay their bills on time. If a lender thinks they're too risky to borrow money - even at high interest rates, then you need to think twice about taking on the responsibility for the loan.
Co-signer's Credit Will be Affected
Many don't realize that co-signing someone else's loan will affect their own credit.
A co-signer is treated exactly the same as the borrower, which means new debt will be added to their credit profile and their debt to income ratio will increase.
These are factors that negatively affect credit scores, so be aware of this and don't co-sign a loan if you need to get a loan in the near future.
Many co-signers end up in a situation where they can't finance a vehicle for themselves because they have taken on too much debt.
Make Sure You Can Afford the Payments
There are a lot of unexpected things that can happen after signing a car loan. People lose jobs, become sick or disabled, and there's always a risk of them dying or simply being irresponsible and not paying their bills.
When you co-sign a loan, you better be prepared and able to pay off that loan.
Co-signing on a loan is legally the same as taking out a loan in your name.
You should do everything possible to minimize the damages in the event the borrower can't pay off the loan.
One thing you can do is ask the lender to agree in writing that you will be responsible only for the principal balance on the loan. You want to be protected against legal fees if the lender decides to sue.
Also ask the lender to be notified if the borrower is late with a payment. You want to prevent any late payments from showing up in your credit report so you should try to rectify the situation before it's reported to the credit bureaus.
Finally, you should only co-sign if you fully trust the borrower. It makes sense if you're co-signing for your child who has no credit history, but it's foolish to do so for a friend who just can't pay their bills on time.
My Recommendation for Car Shoppers
Gregg Fidan + is the founder of RealCarTips. After being ripped off on his first car purchase, he devoted several years to figuring out the best ways to avoid scams and negotiate the best car deals. He has written hundreds of articles on the subject of car buying and taught thousands of car shoppers how to get the best deals.
Why parents should never cosign a student loan
Considering co-signing a loan for an adult child who needs a car, a student loan or a credit card?
You may want to brace yourself for the relationship fallout that could come down the road if he or she stops paying on the obligation — a debt that has your name written all over it!
And that only scratches the surface when it comes to the potential financial damage of cosigning on a loan.
Co-signing a loan can strain relationships
Nobody likes to think about it, but you have an almost four in 10 chance that you’ll be the one who has to pay when you co-sign a loan. That’s according to a CreditCards.com survey that found 38% of the 2,000 adult co-signers they asked were making the monthly payments because the primary borrower was not.
Even worse, that unexpected turn of events led to a breakdown in relations between co-signer and primary borrower about a quarter of the time — 26% to be exact.
On the question of lending money to family and friends — separate from the co-signing issue — Clark has long had two rules.
One, treat it as a one-time only thing. And two, treat any money you lend as a gift, rather than as a loan. That way if you do actually get paid back, it’s a happy surprise!
Co-signing a loan is dangerous to your financial health
Some 17% of Americans have co-signed a loan for a child or someone else, according to CreditCards.com. The most common type of co-singings are a parent co-signing an auto loan for a child. That represents about half (51%) of all the co-signing action, followed by personal loans (24%), student loans (19%) and credit cards (16%).
According to a 2012 report by the Consumer Financial Protection Bureau and Department of Education, about 90% of all private student loans are co-signed by a parent. Sadly, a 2014 Citizens Financial Group survey revealed that 94% of parents with a child in college said they felt more burdened due to their children’s college loans. In addition, around 50% of parents did not have a plan to repay their child’s student loan debt.
When you co-sign a loan, you’re doing more than just giving a character reference for the person. You’re agreeing to pay the debt if they welch on payments — either intentionally or because they lose a job and can’t find another.
So co-signing a loan creates a long-term financial obligation. It is a hazard that should be avoided if at all possible.
Co-signing a loan will raise your debt-to-income ratio. This can really hurt if you’re applying for a mortgage. Clark has long said you shouldn’t go out and get a loan for a car in the months before you plan to buy a home. But your credit score is still at risk if you’ve co-signed a car loan for somebody else.
It may be possible to remove yourself as a co-signer. With private student loans, you may be eligible for a co-signer release once the person you signed for makes a certain number of consecutive on-time payments and has a credit check. But you’ll likely have to stay on the student loan servicer to make this happen. With an auto loan, you can sometimes get off as a co-signer if the person you signed for refinances the loan in their own name.
You may be able to negotiate terms of co-signing beforehand. The Federal Trade Commission suggests that you try to get the following language in the contract: ‘The co-signer will be responsible only for the principal balance on this loan at the time of default.’ That means you won’t be responsible for late fees or court costs if you’re sued over the debt because the borrower is not paying as agreed.
Your untimely passing could throw the borrower into immediate default. Private student loans commonly contain a clause that lets the lender call the loan due in full if you as a co-signer die or declare bankruptcy. The CFPB is recommending people in private student loans try to get a release for their co-signer before something like this happens. They have a series of sample letters to help you get the job done.
Risks of Co-Signing or Co-Borrowing on a Loan
It happens to many of us. At some point, a friend or family member calls you and asks to have coffee. A few awkward minutes into the awkward conversation, you are asked to co-sign onto a loan.
In the wake of the Great Recession, banks toughened their requirements for all types of loans. Borrowers must meet strict income and credit requirements, and many cannot meet these without some help. Banks are more likely to grant someone a loan if the loan is co-signed, meaning that the co-signer is responsible for paying back the bank if the primary borrower defaults.
While it is temping to immediately rush to help a friend or family member, you should first understand your obligations, and know what might happen if the person you are helping with your signature fails to repay the loan.
Two terms describe a person who helps someone else get a loan: Co-signer and co-borrower. A co-signer and co-borrower both:
- use their good credit and income to help someone else get a loan
- are legally obligated to make the loan payments if the other borrower fails to do so
- can be sued by the lender (typically a bank) if the other borrower fails to make payments, and
- can sustain damage to their credit history if the other borrower is late in making payments or misses payments entirely.
However, there is one important difference: A co-borrower is listed on the title to the property bought with the loan money, like a car or a house. This means the co-borrower actually co-owns it. A co-signer is not listed on the title. He or she has no legal claim to the property. (Some would say that this means that the co-signer has all the risks with none of the benefits!)
Be Prepared Before Agreeing to Co-Sign or Co-Borrow on a Loan
Assuming you want to take on the risk, there are some factors to consider before saying "yes" to your friend or family member. It's best to draft an agreement or contract between you and the other borrower. This document should include details about:
- who is responsible for making the payments
- how much the payments will be, by when they are due, and where they need to be paid
- what happens if one borrower doesn't make payments and the other borrower takes over payments; will the first borrower sign over his or her ownership interest in the property to the co-borrower?
- whether, if one borrower is initially relying on the co-borrower/co-signer for purposes of good credit history, the loan will be refinanced later to have the co-signer/co-borrower taken off the loan, and
- who is responsible for paying legal costs and fees if one borrower has to take legal action against the other.
Talk to a lawyer if you need help writing the contract. A savvy lawyer can help make sure all of your bases are covered and your good deed does not expose you to unnecessary potential liability.
What If Something Goes Wrong During the Loan Term?
In the worst possible situation, the person you tried to help might not make payments on time, or at all. When this happens, the loan goes into default, meaning the borrower has failed to meet the loan obligations.
As a co-signor or co-borrower, you face serious consequences if the loan goes into default. You may:
- be asked by the lender to pay what is owed on the loan
- be sued by the lender, or have your wages garnished to pay off the loan
- be responsible for late fees or collection costs charged by the lender, and
- have the late or missing payments, or a court judgment against you, reported to the major credit bureaus, resulting in damage to your credit rating.
To protect your credit history, you would need to make the necessary payments to get the loan out of default. Then, you'd want to deal with the other borrower in order to fix the problem. Here's what you have to think about:
- Can the other borrower repay you for getting the loan out of default?
- Can the other borrower continue making payments? It may be better to sell the property and repay the loan to protect your credit.
- If the other borrower can't make payments, would it be best to take over payments and ownership of the property? (If you take over payments, or the other borrower can't repay what you spent to get out of default, ask that person to sign the ownership interest over to you.)
- If you co-signed the loan and want to own the property, ask the lender about refinancing the loan to get your name on the property's title. You may have to buy the property from the other borrower or the bank.
The decision of whether to help a friend or family member is deeply personal. Regardless, it is a good idea to know exactly what you are getting into before agreeing.
Can I Cosign for a Home Equity Loan If My Name Is Not on the Deed?
According to the Federal Trade Commission, three out of four co-signers are asked to repay the debt.
Lenders extend credit to unqualified applicants who can present a co-signer with significant income and a good credit history. If you fit this criteria, you may be asked to secure a home equity loan for a friend or relative. Home equity loans are credit applications. You do not need to be on the deed to co-sign the loan. Co-signing does come with significant financial risk. Make sure you are ready for the responsibility and issue some safeguards in the loan contract to minimize your total risk.
Homeowners with equity in their property may apply for a home equity loan or line of credit. You take out a loan against your equity in the property. The loan issued is for the requested amount up to the amount of equity in the property. You retain the equity in the home but promise to pay back the amount owed. In return for issuing the funds, the lender places a secondary lien on the property to assure repayment.
You need more than property equity to qualify for a home equity line of credit. Like all credit, home equity loans are based on your income level and past credit history. Even with sufficient equity in the property, you may be denied the loan if you have poor credit or low income. With sufficient income but poor credit, you may receive less-than-favorable terms such as a higher interest rate. Offering a co-signer to secure the debt may sweeten the deal.
Co-signers are joint applicants on the loan. The co-signer uses his good credit history or higher income to secure the loan for the primary applicant. The primary applicant is responsible for making the monthly payments. Should the primary borrower stop, the lender may pursue collection efforts against the primary borrower or the co-signer to recover the money owed.
Co-signing may significantly affect your credit score if the primary borrower stops paying the bill. All account activity reported on the primary borrower's credit report also shows on the co-signer's credit report. Late payments, collection entries and judgments all lower your credit score and decrease your likelihood of getting credit later on. You may also have trouble qualifying for a mortgage loan with a co-signed loan on your credit report. The increased debt load may cause a mortgage application denial.
Get documentation in writing that the lender should contact you if the primary borrower defaults. By getting immediate notification, you may make the payment on the primary borrower's behalf and save your credit standing. You may also request a modification of the loan terms prior to signing to limit your total liability to the balance of the loan excluding late fees, attorney's fees or interest on the total owed.
- Ablestock.com/AbleStock.com/Getty Images
Leigh Thompson began writing in 2007 and specializes in creating content for websites. She has been published online in various capacities. Thompson has an associate degree in information technology from the University of Kansas and is working on a bachelor's degree in business and personal finance.
Free: Money Sense E-newsletter
Each week, Zack's e-newsletter will address topics such as retirement, savings, loans, mortgages, tax and investment strategies, and more.
What to Know Before Cosigning a Student Loan
The decision to co-sign student loans for a child who is a college student may sound like a no-brainer, because what parent wouldnвЂ™t want their child to go to college? But co-signing a loan is a huge responsibility, and can come with massive personal repercussions if your child ends up defaulting on their loans. Here is a bit of information on loan co-signing, and what you can do before you get to the dotted line.
Once you cosign on a loan, you become legally responsible for the loan, and are liable for the debt if the original borrower fails to make payments. Even though youвЂ™re not the main name on the loan, cosigning means you accept 100% of the responsibility of the loan, as if you were receiving the money yourself. If it all goes sour, having this loan on your credit report can limit your ability to take out new forms of credit or refinance existing debt, too.
Loans arenвЂ™t just a financial burden; theyвЂ™re a huge responsibility. So, before cosigning, youвЂ™ll need to have a serious conversation with your child about what could happen to their credit (and yours) if they stop making payments or go into default.
To protect yourself, you can also look into cosigner release, which relinquishes cosigners from their responsibility after the lender has kept up with monthly payments, on time, for a specified period (normally a few years).
Finally, think about any possible credit you might need to apply for in the next few years. Taking on a large new loan, even as a cosigner, could affect your ability to gain new credit. Need home repairs and thinking about refinancing? Cosigning a student loan could get in your way.
Remember, only private lenders require cosigners. Instead of taking on private loans, see if youвЂ™re eligible for a Parent PLUS loan from the federal government. You can still ask that your child pay back that loan, but youвЂ™ll have more protections, and a likely lower interest rate.
If your child is having trouble qualifying for loans beyond the federal student loan limit, they should consider applying for more grants and scholarships. These can help them avoid debt altogether. In fact, before cosigning offer to help them find free money for college.
If all else fails, and you canвЂ™t (or wonвЂ™t) cosign for a loan, it might be time to encourage a gap year between high school and college. Young adults who work full time can save a huge chunk of their paycheck to put toward their college tuition, especially if theyвЂ™re still living at home. Your child might also want to consider studying at a more financially accessible institution, such as community college, even just as a start. Earning good grades at community college may also help them become eligible for more scholarships.