Sometimes, a family member or friend may ask you to cosign a loan or rental application because they don’t have enough credit history or have faced financial challenges. Cosigning means you’re legally guaranteeing the loan will be repaid, even if the primary borrower fails to make payments. While this can be a way to help someone in need, it’s essential to understand the risks and responsibilities involved.
Key Questions to Consider Before Cosigning
Is the borrower financially responsible?
If the borrower has a steady job and is financially reliable but lacks a credit history, cosigning might help them build credit. However, if they’ve struggled with late payments or debt in the past, you’re taking on significant risk by cosigning.
Can you afford to pay off the loan?
If the borrower defaults, you’ll be responsible for the entire loan, regardless of their circumstances (e.g., bankruptcy or disability). Only cosign if you can afford to take over the payments if necessary.
How will this affect your credit?
The loan will appear on your credit report as your own. Late payments by the borrower will hurt your credit score, and the loan will impact your debt-to-income ratio. This could affect your ability to take out loans in the future.
Does the lender keep cosigners informed?
Some lenders notify cosigners if payments are late, allowing you to address the issue before it escalates. Confirm the lender’s communication policy before agreeing to cosign.
What to Do if the Borrower Defaults
If the primary borrower misses payments, act quickly to minimize the impact on your finances and credit:
Contact the borrower:
Reach out to understand the situation. If the primary borrower forgets a payment, you can resolve the issue promptly.
Work with the lender:
Find out how far behind the payments are and if the lender offers options like forbearance (a temporary pause in payments) or fee forgiveness.
Explore refinancing or selling:
Ask the borrower to refinance the loan in their name alone or find a new cosigner. If the loan is tied to an asset like a car, selling it to pay off the loan might be an option.
Consider bankruptcy only as a last resort:
Bankruptcy is a drastic step that affects both you and the borrower. Consult a financial advisor or attorney before pursuing this option.
Final Thoughts
Cosigning a loan is a significant financial commitment that can impact your credit and finances for years. Before agreeing, carefully assess the borrower’s financial responsibility, your ability to take over payments if needed, and the potential impact on your financial goals. If you decide to cosign, stay informed about the loan’s status and communicate openly with the borrower. While cosigning can be a generous act, it’s crucial to balance helping others with protecting your financial well-being.