If you’re fortunate enough to have good credit, there’s a good chance that someday a loved one will call asking for you to co-sign a new loan or a credit card. Maybe it’s an adult son or daughter without much of a borrowing history or one who’s taken a few hits in recent years and needs a co-signer to buy a car. If you’re like most people, your impulse is to lend a helping hand by adding your signature to the loan. But before signing on the dotted line, make sure you know what you’re getting into.
Co-signers can face significant repercussions if the primary borrower can’t make good on his or her payments. Were this not the case, having a co-signer on the loan—regardless of how high their credit score—wouldn’t matter much to the bank. But because the lender knows it can go after co-signers for overdue payments, that second signature can make a world of difference in the loan approval process.
- Borrowers may ask a family member or friend to co-sign a loan due to low credit scores, lack of credit history, or because their loan is offered with a very high interest rate.
- A co-signer on a loan is legally responsible for the debt if the primary borrower defaults.
- Co-signing a loan will show up on your credit report and can impact your credit score if the primary borrower pays late or defaults.
- Co-signers may sign for student loans, personal loans, credit cards, and even mortgages.
The Potential Fallout
What’s the upshot for the co-signer if the primary borrower can’t make the loan payments on time? The creditor may start contacting you seeking the overdue amount, using the same tactics that they use on lapsed borrowers. That means they could sue you and, if they win, garnish your wages.
Of course, by the time a collection agency starts calling, there’s a good chance the overdue payments have already found their way onto your credit report. So despite the fact that you’re not even borrowing the money in any real sense, your credit could start to take a hit. All of a sudden, obtaining loans—or at least getting preferred interest rates—can become a big challenge.
The important thing to keep in mind is that, legally, co-signers are every bit as responsible for the debt as the person they’re helping out.
Keep in mind, too, that you could remain on the hook even if the person you’re helping out files for bankruptcy. If the note you co-signed was part of the court filing, the creditor can still come after you in hopes of collecting on it.
Even if you acted as a “guarantor” on the loan rather than a co-signer, you’re in pretty much the same boat. There are some slight differences between the two. For example, with a guarantor, the lender has to pursue the primary borrower before contacting you. But you’re ultimately responsible for any late payments, just as you would be if you had co-signed.
Before You Sign
To avoid any unnecessary headaches later on, it’s important to think through your decision before putting your name on someone else’s loan. Here are three tips that can help keep you out of trouble:
Understand the Consequences
If you’re a co-signer, the creditor has just as much right to collect from you as from the actual borrower.
Stay in the Loop
The only thing worse than having a collection agency breathing down your neck is not knowing ahead of time that the loan wasn’t being paid. Before co-signing a note, the Federal Trade Commission recommends asking the creditor to notify you if the borrower falls behind on their debt. For peace of mind, make sure to get this agreement in writing.
Be Careful About Collateral
If you put up assets to help someone secure a loan—whether it be your car or an expensive piece of jewelry—know that the bank can sell them to help pay off unpaid debts. Make sure you’re ready to handle that reality in a worst-case scenario.
The Bottom Line
It’s easy for those with good credit to follow their heart and instinctively co-sign for loved ones who need a loan. But, to avoid trouble down the road, it’s always a good idea to take emotion out of the equation and think through the consequences.