Co-Signing a Loan: The Good, the Bad and Possibly the Ugly

Co-signing happens pretty frequently in the world of lending and loans. It’s a way for someone with better credit to help someone who struggles with their finances and credit. This practice is most common among close friends and family members as it requires a good relationship with lots of trust.  It sounds harmless.  Just sign your name, and a friend or relative will get a much-needed credit card, line of credit or car loan. Like most things in life, however, being a co-signer is not that simple.

Like most financial commitments, understanding all the risks and benefits is the best way for you to make the right choice. Here is the good and the bad when it comes to co-signing a loan.

What does co-signing mean?

Co-signing for someone else’s loan is one of the least understood arrangements in finance.  When friends and relatives co-sign, they often don’t realize that the new debt is also theirs.

If you’re being asked to co-sign on a credit card it’s usually for one of three reasons:

  • The person asking you to co-sign has a poor credit history and is deemed too great a risk by the credit card company or their income is insufficient to pay the debt. This should give you cause to pause.
  • The person is very young and has no credit history (and not earning enough money to be considered a good credit risk). This should also give you cause to pause.
  • You are co signing for your child for a credit card with a very low limit as part teaching your child to use credit wisely and to help them get a good credit score. This includes the parent willing to cosign for a credit card for a child under the age of 18.

Simply put, co-signing means that you are helping another person who can’t get a loan, get a loan. You’re putting your name and credit history onto someone else’s loan, thus making yourself responsible for their loan in the same way that you would be responsible for your own loan.

The Good

It helps a friend or family member obtain financing

Being rejected for a loan because of poor credit is a reality that many people have to deal with.  Co-signing a loan could help someone you know who may not be a great credit risk become a better credit risk and improve their score by virtue of them making the payments.

Helps build credit for both signers.

This is where a co-signer can be beneficial. Someone who has a good credit history can co-sign a loan to help a person with bad credit and therefore help them build their credit.  And since the person who is helping is attached to the loan in the same way as the primary signer, their credit score will also benefit if the loan payments are made on time and loan is paid off on time.

Better interest rates.

People with bad credit scores and history have to pay higher interest rates because they are seen as high risk by lenders. But if they can get a co-signer who has a good credit history they will benefit from that person’s credit strength and therefore be offered a more favorable interest rate.

Avoid Lenders of Last Resort

By getting a co-signer a debtor may be able to avoid using a lender of last resort.  Having a person with good credit co-sign your loan will allow you to be eligible for a higher quality loan from a lender who is not looking to take advantage of you.

The Bad

You will get no “material” reward

This is the most obvious reason why co-signing for a loan, a car or even a mortgage could be a bad idea. There is no “material” benefit to you, you won’t get to drive the car or live in the house but you’ll be responsible for the payments. If the person you’re co-signing for is unable to make a payment then it will be up to you to pay it. (see the Ugly)

You are responsible for the loan.

If you co-sign a loan with someone you are likely the only reason they can get the loan.  Your good credit score and history is why your friend or family member with a bad credit score and history is able to get a loan.  No other reason.

If the payments stop being made then the person with the good credit, which is you, will be held legally responsible because you are more likely to be able to pay off the debt.  In essence, what it means that if something goes wrong, you are saying to the lender, don’t worry I will pay the balance.  Is that what you intended in the first place.

You could be rejected for a loan you need in the future.

Co-signing a loan now could make it impossible for you to get a loan if and when you need one. Think about your future carefully before you decided to co-sign a loan. You might not think you’ll need a loan in the near or even distant future but you never really know and you don’t want to be rejected if the time comes.

You should ensure that the payments are being made.

Even if your friend or family member promises they are making the payments, you will still need to check for yourself. Simply putting it to the back of your mind and not checking up on them every month is not really an option.  Remember who the lender is going to call upon if payments are missed.  You will have to treat it like all of your other monthly bills and stay organized and on top of it.

The Ugly

Payments are missed.

You get a call from the lender advising you that the payments have been missed and you are called upon to make up the missed payments.  This could negatively impact your good credit score.  Then you need to make that uncomfortable call to your family or friend and ask what’s going on.

You get called on the loan, you will have to make the payments.

Prepare yourself to make the payments no matter what.  Since you have taken on the responsibility of being a co-signer you need to protect yourself and your credit score. Put aside some money just in case the other signer defaults and be prepared for the worst.

The relationship may be forever damaged.

Wanting to help a friend or family member is never a bad idea but when you’re asked to help them out financially you should think carefully about the consequences. Depending on the situation the good can outweigh the bad but the bad can also become the ugly.  The best idea for both parties is to have the best understanding of what co-signing a loan really means, that way if you have the opportunity to help out a friend you’ll be able to say yes to with confidence.  Having it in writing is a good idea.  However, ask yourself is your relationship worth it to co-sign for the other party.

How do you get out of it? 

If you do decide to go ahead and co-sign a loan, ask the lender, in writing, to keep you informed of all activity on the account. By doing this you may be able to identify a problem in its early stages, and correct it before it affects your credit rating. You should also insist on receiving a copy of every document you sign. If you must co-sign for someone, be sure you have all the facts clearly explained to you prior to signing, or you could end up regretting what you have just done.

If you need to end the arrangement usually the lender will ask for full payment.  You need to consider if you have the funds available to do so.

What to do if you have been called on to pay the loan and it puts you in a financial bind.

Co-signing can be risky business.  If you’re experiencing serious debt issues, contact Boale, Wood & Company Ltd., Licensed Insolvency Trustee at (604) 605-3335 for a no cost, no obligation consultation.  You have nothing to lose by taking an hour of your time to ask us a few questions so you can make an informed decision.

Call us, it’s not too late.