Personal Finance: Is It a Mistake to Co-Sign on a Loan?

It is wonderful to help your friends and family, and many of us aspire to be there to support our loved ones in their times of need. When money is added to the equation, however, this can add another wrinkle to the relationship, one that is not always for the best. If one does not qualify for a loan, a co-signer can help the applicant obtain financing. But, is this a mistake?

The mixture of money with friends and family is a sensitive topic. Before agreeing to co-sign a loan, make sure you understand the full implications of this action.

What Does It Mean to Co-Sign on a Loan?

Co-signing on a loan can have a significant impact on your personal finances. By agreeing to co-sign a loan, you are lending your good faith and credit history to the financial transaction.

Your friend or relative who has few assets, a less pristine credit score, or a combination thereof will take advantage of your financial history to secure financing for their desired purpose. In theory, your obligations will end there, as your friend or relative will repay their obligations on time and in full.

However, life does not always go according to plan. When you co-sign a loan, you are entering into a legal agreement to repay the entirety of the loan amount. The loan will be part of your financial records, with potential lenders able to view this transaction, which could impact their willingness to provide you with financing.

And, if the individual that you co-signed for becomes unable to repay their debt, you will be on the hook.

What Happens if the Loan Is Not Repaid?

If you co-sign on a loan that is not repaid, the lender will look to you to make up the missing obligation.

This can have a number of repercussions, the first and most vital of which is that you may need to fork over your money to repay the lender. If doing so would put you in financial straights, think long and hard about whether this is a risk worth taking.

However, the implications of being a co-signer on a non-performing loan run deeper. Credit scores are calculated in part by your ability to make on-time payments towards your obligations. This holds true for loans that you have co-signed, even if you are not the one directly responsible for repaying them. If your friend or relative makes late payments while servicing the loan, your score could feel these impacts.

Beyond the financial harm, it goes without saying that this arrangement has the potential to put a damper on your relationship. Just as with lending money to friends and family, you may grow to resent the individual who messed with your finances.

When to Consider Co-Signing the Loan

Though co-signing a loan can expose you to some acute financial risks, there are still reasons to consider taking this leap.

For one, co-signing a loan can help your friend or relative achieve their dreams and desires. Whether it is purchasing a car, going to school, or putting down roots in a community by purchasing a home, co-signers can step in to help secure financing.

This can be a wonderful deed you can offer a loved one, with long-term benefits that extend well beyond the money.

If you are ready to look beyond the downsides and take on this obligation, make sure you are fully aware of the individual’s intent and capacity to repay the loan. Ideally, this is an individual that you feel close to and know well. This should give you a strong sense of their level of responsibility and whether or not they can be trusted to make their loan payments on time.

Still, to protect yourself further, it would be a good idea to set aside money in case some payments are missed. Make sure that you are in regular communication with the individual that you co-signed for, and ask for a commitment from them to notify you immediately if they find themselves in financial difficulties. In addition, you could ask the lender to notify you in the event of a late payment so that you can take action to address any shortfalls immediately.

Conclusion: When Personal Finance Is No Longer Personal

One of the basic tenets of personal finance is that your actions and decisions are yours. You control your spending and savings decisions.

Co-signing on a loan flips this arrangement on its head. You will be held responsible for someone else’s actions, for better or for worse.

This decision can have severe repercussions on your finances. For this reason, it is vital that you are confident in your loved one’s ability to repay the loan. It is just as important to have a full understanding of the consequences of serving as a co-signer before signing on the dotted line.

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