Things to Consider Before Co-Signing a Loan

If a family member or close friend has asked you to co-sign a loan, you might find it difficult to them down. Co-signing a loan means that you will be responsible for making the loan payments if the other party fails to pay on time.  This can be a big responsibility for most people, so you do need to make sure you are in a solid financial position before you proceed. If you don’t review all the terms and conditions of the loan carefully, and don’t understand the effects of taking on this loan in the long-term, you could be setting yourself up for your own set of financial problems.

Here are some important things to consider before co-signing a loan:

Your Credit Report

The loan will show up on your credit report. The full balance of the co-signed loan will show up on your credit report as if it is your own loan. This may negatively affect your credit report and make it difficult to maintain a high credit score. If you’re worried about your credit score or credit rating, consider the drawbacks of adding a loan to your record.

Effects of Default

You do run the risk of being responsible for the entire loan at some point. The Federal Trade Commission reports that 75% of co-signers end up having to pay for the loan they helped the applicant get because the applicant defaults on the loan. Make sure you are financially prepared to take on such a responsibility. This may mean setting aside some of your own savings for the loan payments or working extra to build up an emergency fund or cash cushion.

Your Creditworthiness

You may not be able to get a loan in the future. If you are planning to apply for a mortgage, car loan or other type of loan in the near future, having this loan on your record could prevent you from getting the loan you want. Even though the other person on the loan papers may be making the payments, banks and creditors will consider the co-signed loan to be your sole responsibility. This means you will have a higher debt-to-income ratio on your record, even though the actual monthly payments you are making are much lower than what’s reported.

Encouraging Bad Financial Habits in the other Borrower

You could be preventing the other borrower from developing good financial habits. If the person you are co-signing the loan for is a child or even a sibling, you may be “spoiling” them by helping them out with this loan arrangement. If you are co-signing a loan for your child, make sure that they understand the importance of making their monthly payments on time and that you are only helping them out so that they can build some credit.

Co-signing a loan can be a big responsibility and you need to consider how taking on this loan will affect your credit report and financial standing. Remember that you will be responsible for paying the loan in full if the other borrower fails to make a payment. Consider all of the above when asked to co-sign a loan so that you can make the most informed decision.