If your family member or friend comes to you asking that you cosign a loan for them, give this question a hard thought before saying “Yes.” There is more to it than just putting your signature on the borrower’s loan documents. It may be hard to say no to a friend or relative when they are in dire need of a cosigner, but many cosigners later wish they had the courage to say it. According to a survey by creditcards.com, almost 40% of cosigners find themselves paying for other people's loans because the primary borrower has defaulted.1
However, cosigning doesn’t always end badly. Here are five crucial questions to ask yourself before putting pen to paper – if you want things to end well.
1. What Exactly Is Cosigning for a Loan?
You must first understand the basics of cosigning to be on the right path. When you cosign a loan, it means that you are guaranteeing someone else’s debt and you will be required to pay if the borrower fails to raise the payments. It doesn’t matter whether you benefited from the loan or not – basically, it’s also your loan. You need to be sure that you can afford to pay the debt if you are required to, which could be the full amount if the borrower is not able to pay any cent. It’s also good to note that if the debt is in default; your credit record may be affected.
2. Who Is the Borrower to You and What’s the Loan’s Purpose?
It is imperative to scrutinize your relationship with the borrower and determine what they are planning to do with the loan before co-signing on it. Are they a student looking for college education fees? Are they a friend who wants to buy a car or apartment? Do they want to start a business?
In all cases, it is possible that unforeseen circumstances could arise and make it impossible for the borrower to repay their loan. A student could drop out or finish their education and fail to get a job, leaving you with thousands of dollars worth of debt. Your friend’s business could fail to pick up and make them miss on payments. There are so many scenarios that could lead to a borrower failing to make due on their payments. So, cosign only when you can afford to take on the entirety of the debt.
3. Why Does the Borrower Need a Cosigner?
You are entitled to ask as many questions as possible about why the borrower needs a cosigner. You need to understand their financial history and behavior thoroughly before agreeing to anything. Find out their level of discipline in making timely payments, managing finances, and maintaining a healthy credit score. Also make sure to ask about their employment history and current financial status (income, expenses, credit, etc.) That may be an uncomfortable conversation to have, but it’s crucial that you know their finances well before taking any risks.
4. Will You Be Able to Reach Your Other Financial Goals While Cosigned to the Debt?
If you are planning on applying for credit yourself or refinancing your home in the near future, it would be best that you don’t cosign any loans now. In the eyes of a lender, a loan that you have cosigned is part of your debt, and hence it will be hard for them to give you credit until it’s fully repaid.
5. What Would Happen to the Relationship With Your Cosigner If They Default?
According to Forbes, 26 percent of individuals who cosigned loans ended up in rocky relationships after the primary borrowers defaulted.2 As mentioned earlier, cases of default are rampant – with around four in every 10 people defaulting and leaving the debt burden to cosigners – and hence it’s important to decide if you are ready to sacrifice your relationship with a friend or relative if they fail to pay.
If you are thinking of cosigning for someone, make sure both of you understand the process in detail to safeguard your finances.
Have a Question?
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Luis Rosa CFP® EA is the founder of Build a Better Financial Future, LLC. He has been in the financial services industry since he graduated college in 2001. Luis focuses on empowering people with planning tools and action steps to help position themselves for a better financial future.
Luis has been quoted in articles published in Yahoo! Finance, U.S. News & World Report, NBC News, Investopedia, Business Insider, The Daily News, and several other online publications. In addition to obtaining his securities registrations Series 6, 7, 63, and 66, Luis is also a CERTIFIED FINANCIAL PLANNER™ professional and is enrolled to practice before the IRS. This diverse financial knowledge allows him to best serve his clients by understanding how one financial decision affects the other, allowing him to better guide them toward achieving their goals. To meet and see how Luis may be able to help, contact Luis directly at Luis@buildabetterfinancialfuture.com.
Investment Advisor Representative of Retirement Wealth Advisors Inc. (RWA), 89 Ionia NW, Suite 600, Grand Rapids, MI 49503 (800) 903-2562. Investment Advisory Services are offered through RWA. Build a Better Financial Future and RWA are not affiliated.This information is designed to provide general information on the subjects covered, it is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Build a Better Financial Future, LLC and its affiliates do not give legal or tax advice. You are encouraged to consult your tax advisor or attorney.