The decision to cosign is a complicated one, since the desire to be supportive of a friend or family member sometimes conflicts with financial common sense. Offering help can be risky, especially if clean credit is on your list of priorities. Consider the points below before lending a hand.
1. Credit cause and effect
Many people do not realize the financial effects of cosigning a loan. Just like any other debt, a cosigned account is likely to appear on your credit report, causing a change in your “utilization” ratio (an indicator of how maxed out you are with revolving credit accounts). A sudden rise in your utilization ratios can affect your personal finances in many ways, including lowering your credit score and therefore your ability to secure your own personal loan (e.g., auto, mortgage, etc.). It can also affect the type of interest rates you receive. To make matters worse, non-payments and late payments, even if made by a friend or relative for whom you’ve co-signed, have the power to hurt your credit as well, even though you are not the primary borrower. Remember that the way they handle the cosigned account will appear on your credit report as your responsibility as well. Placing the fate of your own clean credit in another person’s hands is usually a bad idea—a fact learned too late by many cosigners.
2. Facing the burden
A cardinal lesson in borrowing money is making sure you can repay it. This lesson is an important one for cosigners as well. Before agreeing to cosign for your cousin’s auto loan, ask yourself the following question: “Can I handle the payments if he doesn’t?” Make no mistake, lenders want their money, and they will hold you responsible if necessary. Assess your own finances and decide if you could handle the expense on your own. The answer to this question will tell you if cosigning is an option.
3. Responsibility and the unknown
Whatever the circumstance, the #1 reason lenders require a cosigner is this: the primary borrower is considered a risk. While some are risks due to less-than-clean-credit, others don’t yet have the credit history to support their application. Remember that cosigning effectively means that you are vouching 100% for the debtor in case they cannot (or decide not to) repay the loan in accordance with the agreed-upon terms.
4. Relying on other options
Who says cosigning is the only way to be supportive? Putting your own credit on the line isn’t the smartest choice, so why not find another way to help your friend? If you have the means, offer a cash gift in lieu of a loan signature. If your college-bound sister needs money for room and board, offer the spare bedroom in your home, access to the washer/dryer, or even the occasional lunch and dinner. Caring doesn’t have to mean leaving your financial fate to chance.
5. Preserving your relationship
Money is a swift and sure way to divide relationships. Consider how you would feel upon receiving a call from your cousin’s bank informing you that the auto loan you cosigned is in default. Suddenly, an act of kindness on your part has become a breeding ground for tensions, resentments, and overall heartache. Do yourself a favor and protect your relationship by finding other ways to offer support. While your friend or family member may be hurt in the short-term, you are more likely to ensure a lasting relationship.