repost­ed from: Loans.org
by: Rebekah Cole­man
Feb­ru­ary 19, 2013

To sign or not to sign?

That is the ques­tion fac­ing many con­sumers. The elu­sive co-sign­ing role is one that respon­si­ble bor­row­ers should avoid at all costs.

Every day, con­sumers with sta­ble cred­it his­to­ries decide to assist their friends and fam­i­ly mem­bers and co-sign a loan, such as per­son­al loans, stu­dent loans, or auto loans.

But co-sign­ing is about much more than sim­ply adding one’s name to an agree­ment. That sig­na­ture brings with it five major threats for a co-sign­ing con­sumer.

If after read­ing these rea­sons you would rather pass on co-sign­ing a loan, encour­age your fam­i­ly mem­bers to try apply­ing for a per­son­al loan them­selves using this free online appli­ca­tion.

Rea­son 1: More Risk, Less Reward

Co-sign­ing a loan is almost the same as apply­ing for the loan by one­self. The only dif­fer­ence is that a co-sign­er does not ben­e­fit from the risk.

How­ev­er illog­i­cal it seems to a dis­grun­tled co-sign­er, he or she is just as respon­si­ble to repay a co-signed loan in its entire­ty as the pri­ma­ry bor­row­er is. The inher­ent rea­son for an addi­tion­al sign­er is to add extra secu­ri­ty and pre­cau­tion for the lender. If a per­son was linked to the loan, but did not have to repay the loan them­selves, it would not assist the lender.

Gail Cun­ning­ham, vice pres­i­dent of mem­ber­ship and pub­lic rela­tions at the Nation­al Foun­da­tion for Cred­it Coun­sel­ing (NFCC), said that co-sign­ers should pre­pare from the very begin­ning to repay the loan them­selves.

“Nev­er co-sign on a loan that you are not pre­pared to repay in full,” Cun­ning­ham told loans.org.

A bor­row­er and a co-sign­er will be pun­ished equal­ly for their fail­ure to repay a loan. For the pri­ma­ry bor­row­er (who like­ly already has a poor cred­it score), this will prob­a­bly not impact their dai­ly life as much as it will impact the co-signer’s.

If the pri­ma­ry bor­row­er applies for oth­er forms of cred­it, their low score will like­ly con­tin­ue to get their appli­ca­tions reject­ed. But for a safe bor­row­er with a good cred­it score, being refused on a per­son­al loan appli­ca­tion is an expe­ri­ence they are less accus­tomed to.

Some con­sumers decide to co-sign a debt because they want to add pos­i­tive his­to­ry to their cred­it score, but that can back­fire. After all, most co-sign­ers do not need help with their cred­it.

Since they were approved as a co-sign­er, their his­to­ry is like­ly high enough for approval on most future bor­row­ing. As a result, the pos­si­ble “ben­e­fit” of achiev­ing a high­er score is min­i­mal at best, espe­cial­ly when that ben­e­fit is placed side-by-side with the pos­si­ble con­se­quences.

“Co-sign­ing is tak­ing on new cred­it, thus could neg­a­tive­ly impact the cred­it uti­liza­tion ratio of the co-sign­er,” Cun­ning­ham said. “Co-sign­ing could poten­tial­ly use up avail­able cred­it that the co-sign­er might need for him­self.”

Rea­son 2: Inhibits Future Bor­row­ing

Co-sign­ing a new loan can inhib­it a co-signer’s future bor­row­ing abil­i­ties.

When lenders decide whether or not to approve an appli­ca­tion, they look at a borrower’s debt-to-income ratio, in addi­tion to their cred­it score. If a co-sign­er puts their name on sev­er­al loans, their debt lia­bil­i­ty will like­ly over­whelm their poten­tial to repay the loans if they go into default.

Being a co-sign­er on one or more loans can pro­hib­it one’s own abil­i­ty to apply for their own loans because they become a high­er risk in the eyes of a lender.

In addi­tion, apply­ing for or co-sign­ing on new cred­it puts an addi­tion­al inquiry into a person’s cred­it report, which tem­porar­i­ly low­ers their cred­it score.

Cred­it is not lim­it­less. Bor­row­ers and co-sign­ers need to think about future pur­chas­es in order to make a log­i­cal deci­sion about co-sign­ing. Many lenders will view mul­ti­ple open loans on a cred­it report as too risky, espe­cial­ly if the person’s income lev­el is mod­er­ate at best.

Rea­son 3: Added Legal Wor­ries

If the pri­ma­ry bor­row­er defaults on a co-signed loan, some lenders may sue for the remain­ing bal­ance and dam­ages.

Lenders will go after the con­sumer with the high­est like­li­hood to repay the debt. In some sit­u­a­tions, the bor­row­er is not con­tact­ed in the begin­ning, and the lender sues the co-sign­er from the start.

For the two peo­ple involved in the loan agree­ment, the per­son with the high­est cred­it his­to­ry will like­ly be sued first, and this is almost always the co-sign­er.

Rea­son 4: Destroyed rela­tion­ships

Mon­ey issues are one of the most com­mon rea­sons for fam­i­ly dis­agree­ments.

Mack­ey McNeill, CPA and finan­cial plan­ner, told loans.org of a sto­ry where fam­i­ly rela­tion­ships were threat­ened because of a loan.

One of McNeill’s clients co-signed a stu­dent loan for her niece. The loan default­ed at a dif­fi­cult time, right after the co-sign­er moved into a new home and lost her job.

The only sav­ing grace for the co-sign­er was her pre­vi­ous­ly saved assets. She used about 25 per­cent of her non-retire­ment assets and sav­ings to pay off the debt, even though she need­ed to use the mon­ey to keep her afloat dur­ing her peri­od of unem­ploy­ment.

With­out these, McNeill said she would have tak­en a seri­ous hit on her cred­it report.

The niece nev­er repaid her debts. Adding fur­ther insult, McNeill said the niece could have done more to keep the loan from default.

“Most young folks have lit­tle finan­cial edu­ca­tion and they believe if they just grad­u­ate, they will be able to repay the loan,” McNeill said.

The bur­dens that stu­dent loans, per­son­al loans, and auto loans place on fam­i­ly mem­bers are dif­fi­cult to over­come for most.

“Col­lect­ing old debts from a fam­i­ly mem­ber is chal­leng­ing at best and a sit­u­a­tion most of us want to avoid,” McNeill said. “Just because you always paid your debts, doesn’t mean oth­er peo­ple do.”

Rea­son 5: Lack of Con­trol

Co-sign­ing a per­son­al loan is a bad idea because it takes away the co-signer’s con­trol. Co-sign­ers are not the pri­ma­ry con­tact for the debt they’re linked to, unlike how they would be with a nor­mal bill.  Report updates will be sent to the main bor­row­er first, and it is up to the co-sign­er them­selves to ensure that the pri­ma­ry bor­row­er is repay­ing the debt on time.

Co-sign­ers can request pay­ment reports and sta­tus updates, but since the loan is for anoth­er per­son, it is up to the actu­al bor­row­er and the lend­ing com­pa­ny to decide if the reports will be dis­trib­uted to the co-sign­er as well.

The co-sign­er needs to review yet anoth­er bill each month, fur­ther weigh­ing down their finan­cial respon­si­bil­i­ties.

Although it might cause hurt feel­ings in the short-term, co-sign­ers should be just as crit­i­cal of their friends and fam­i­ly mem­bers’ cred­it his­to­ry as a bank is when decid­ing whether or not to pro­ceed with joint­ly sign­ing a con­tract. If con­sumers elim­i­nat­ed their feel­ings from the equa­tion, almost all would see that co-sign­ing a loan is nev­er a good idea.

To read at Loans.org please click here.

Relat­ed Arti­cles:

To Buy or Not to Buy: Find­ing Your Mon­ey Edges

Ask Your­self these 3 Ques­tions Before Jump­ing into the Real Estate Mar­ket

From the Archives: What are we teach­ing our Chil­dren about Mon­ey?