Will Co-signing a Loan Affect My Credit?

It can be a nice feeling to have a good credit score. The fact that it will be easier to apply for loans can ease your stress. With all the work you've done, you may want to share it with others, especially a friend who needs a loan co-signed. You should still keep up with your credit card payments and pay down your balance, but think before you go through with this situation. While helping a buddy out with his or her finances can make you feel pretty nice, you should avoid co-signing the loan. All the work you did to get your score to a higher rating can be quickly erased if you decide to go this route. Here are a few reasons why you shouldn't co-sign a loan:

Little upside
Your conscience may feel good at the end of the day, but there is little upside that will come out of co-signing a loan. It's basically a no-win situation for yourself, as you're taking on all the risk and will not benefit from the loan.

Larger repayments
If the borrower who originally asked you to co-sign a loan defaults, you have a long road ahead of you. First, if the other co-signer has not made payments on time, you will start to see the impact on your credit score. If the borrower defaults on the loan, you will be responsible for repayment. Many lenders will present you with a short repayment schedule. For instance, Bankrate reported that there could only be 12 payments. Depending on the size of the loan, this small length of repayment could hurt your overall finances because it could be more expensive. You may have to reconfigure your budget and save more to accommodate this new line of debt.

Legal action
Continuous missed payments can hurt your credit score, because a default could stay on your credit report and you might be sued. Because you have the higher credit score and are the most trusted of the two who signed for the loan, a lender will come after you to repay it. Failure to cooperate with the lender could mean you will be sued to recoup the lender for its losses. The settlement could be costly, and you may have to pay court costs, attorney fees and any late charges.

In danger of being a tax liability
In some instances, a lender may not want to sue you, so it will agree to settle part of the loan. You could have a tax liability if you go this route. For instance, if you need to pay the lender $5,000 and you settle for $2,000, you will have to report the $3,000 as debt-forgiveness income on your tax return. This could show up on your credit report, thus hurting your finances for years to come.

Relationship troubles
While your finances and credit can be hurt during this process, your relationship with the borrower can be damaged too, as trust is lost.