Why You Shouldn't Be a Co-Signor on a Loan
One of the biggest financial mistakes one can make is to co-sign a loan for another person. There is a good chance that the co-signor will end up paying off the loan since the person taking out the loan had bad credit or a history of not paying bills. This is why almost all states require a co-signor to be told in writing of the risks of co-signing for another. A typical notice might read as follows:
"You are being asked to guarantee this debt. Think carefully before you do. If the borrower doesn't pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility. You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount. The creditor can collect this debt from you without first trying to collect from the borrower. The holder of the loan can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, the fact may become part of your credit record."
Think carefully about why you are being asked to co-sign a loan. When a lender requires a co-signor to guarantee the debt, he believes the borrower is at very high risk of defaulting on the loan. This is the very reason you should not co-sign, particularly since it is estimated that 75% of those who co-sign wind up paying some or all of the debt owed by another. Can you afford to make a $300 monthly car payment for another person once, twice, three times or more? This is what you will be asked to do if the person for whom you are co-signing doesn't make a monthly payment.
Should you co-sign for your children, particularly when they are 18 and just starting out in life? Perhaps you should since it is difficult for an 18 year old with no credit rating to get a car loan, therefore, a parent is usually required to co-sign for that first vehicle. However, if your child has a history of irresponsible behavior, you might want to refuse to co-sign at all.
It's a very bad idea to co-sign for your adult children who have been on their own for awhile. This is because in the USA, where the economy operates on credit, you are considered weird if you haven't established a credit rating by the time you're 22 or 23 years old. Once you get a job, the credit card offers start arriving in the mail. Actually, you don't even need a job to get credit if you go to college. Credit cards are handed out on college campuses like penny candy. New immigrants literally get their first credit card just months after arriving in this country.
So, when your 30 year old child or other relative or friend asks you to co-sign, warning bells should go off in your head. Why does he need a co-signor at his age? He should have established a credit rating a long time ago. The truth is he or she needs you to co-sign because his / her credit rating is so bad that no one in their right mind is going to give him a loan without a co-signor. Remember -- about 75% of those who co-sign wind up paying some or all of the debt owed. In addition, if the other person files bankruptcy, the co-signor is required to pay the debt.
Co-signing also damages your credit rating. Since you are legally responsible for paying the debt you co-signed for, the account is placed on your credit report. This can negatively impact your credit rating because you have acquired additional debt. For example, if you co-signed the car loans for your three adult children, your credit report shows that you have three active car loans. You better hope you don't need to buy a new car yourself since you will be turned down because you have too many car loans (dealerships will usually turn down any person or couple who already have two open car loans). Ironically, your bank might ask you to get a co-signor!
In addition, if the borrower defaults on the loan, the late and missed payment notations will appear on your credit report. If the borrower does default, you need to step in and make the payments so that your credit rating is not negatively impacted. Unfortunately, the co-signor usually isn't notified that the borrower has defaulted until he has already missed a payment and the credit report has already been damaged. Getting those late payment notations removed from your credit report is very difficult or impossible, so it's better to avoid them in the first place by refusing to be a co-signor.
Can you change your co-signor status? You can not stop being the co-signor just because you're afraid the borrower will default someday. You signed the contract, so as long as the borrower pays as agreed, you can't bail out unless all parties agree to alter the terms of the original agreement. If the borrower defaults, you have the right to repossess the collateral (providing he hasn't run off to another state with it). You can keep it and use it yourself, or sell it to pay off the loan. You can then, in turn, file a suit against the borrower in small claims court to recover whatever money you lost as a result of the borrower defaulting.
If you are a person with bad credit and need a co-signor, consider all of the above before asking a person to co-sign for you. Even if you pay as agreed, you are damaging the co-signor's credit rating to some degree, since additional debt will appear on their credit report. A higher debt-to-income ratio can result in their having to pay a higher interest rate for their own financing! It might be a better idea for you to put off a purchase until such time that your credit is good enough to obtain financing on your own. This might mean driving an old, clunky car for another year, but it's better than risking the credit rating of someone you love.
The next time a lender asks you to get a co-signor, find out exactly what your credit score is and make a concerted effort to raise it high enough so you don't need a co-signor.
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