Cosigning A Loan? Practical Steps to Help You Make the Decision

You might be asked to cosign a loan for a car you don’t drive, a college you don’t attend or a house you don’t live in, but that does not change your liability. When you agree to put your name to paper on a joint loan, you’re assuming a risk a lender isn’t willing to take on—and it can have negative consequences, both in the short and long term.

For borrowers with less than perfect credit reports or a limited credit history, getting approved for a loan can be a struggle. With the help of another creditworthy signer vouching the debt will be repaid on time, the odds of securing a credit card, car loan, mortgage or a private student loan improve dramatically. What that means is that a third party (in this case, you), in addition to the primary borrower, assumes full responsibility for ensuring the terms of the loan agreement are fulfilled.

Many people offer to cosign a loan for their child or spouse, but even then you need to think about the repercussions of that obligation. It is important for a cosigner to understand that the borrower needs a cosigner for a reason. The question becomes, are you willing and able to—and should you—take on that risk when the lender won’t?

Before agreeing to cosign a loan, consider the following obligations:

· If the borrower passes away, you assume the same responsibilities for the deceased as if you applied for the loan yourself.

· If the borrower misses even a single payment on a loan, a lender may have the ability to demand full repayment of the entire outstanding balance on the loan immediately, from you.

· If the borrower defaults, additional penalties, including late fees, higher interest rates and other charges, may be piled on top of the amount owed, and you are responsible for those penalties and fees.

· If the borrower defaults on the loan and it moves into the collection process, the lender may collect the debt from you. That means the lender may be able to take legal action against you.

· If the borrower makes late payments, your credit may be damaged. .

These are important considerations, because they have an immediate impact on your financial freedom. For example, this new debt obligation will appear on your credit report and will impact your debt-to-income ratio. Debt-to-income ratio is the percentage of your monthly income that must be applied to your repayment obligations to debtors. As a result, your capacity for future borrowing will be diminished. The extent of how much weight this carries in the decision-making process will vary from person to person, as people have different income and debt levels, but it is something that needs to be looked at.

In addition, you are responsible for the actions—or lack of action—of the primary borrower. If your credit score takes a hit because of lack of timely payments and/or failure to make payments, it will impact your financial life and decrease your credit score. This is important because your credit score largely dictates the interest rates you qualify for on future loans or credit card applications. Lower credit scores can increase the cost of your auto and homeowners insurance because premiums are based, in part, on your credit history. Also, if you want a vacation home, you will pay a higher interest rate on the mortgage. The same is true for auto loans or personal loans.

If you are still willing and able to take the risk as a cosigner, be sure to get copies of all the loan documents, plus the repayment schedules. Research whether you have any cosigner rights under your state’s law. Make sure you understand your obligations under the terms of those documents. Ask the lender to agree in writing to notify you as quickly as possible if the borrower is late with a payment, misses a payment or is otherwise in default. That way you can make the missed or late payment(s) to prevent damage to your own credit report.

Also ask the lender to calculate the amount you might owe. According to the FTC, you may be able to negotiate specific terms of your obligation. For example, you may be able to limit your liability to the principal on the loan and not the late fees, court costs or attorney fees. Ask the lender to include a clause in the contract that states: “The cosigner will be responsible only for the principal balance on this loan at the time of default,” before you cosign the loan documents.

There’s a popular saying with financial planners: you can’t borrow money for retirement. The idea is that your first obligation is to secure your own financial future. Be certain that you can afford to make the payment on the loan you cosign while maintaining your other financial obligations. If you cannot, do not cosign any loan document. Because as much as you may want to help a friend, loved one or family member, you simply can’t afford to take the risk.

Jane Ensley manages the Enumclaw branch