Why Co-Signing for a Loan Isn’t a Good Idea

It’s invariably happened to you or someone you know: Someone asks you to co-sign on a loan for them, whether it’s a car loan or a mortgage (but more often than not, it seems to be a car loan).

It begs the question: Should you co-sign on a loan? Ever?

The folks who will actually have the gumption to ask for your John Hancock — and the use of your credit score — for a loan are usually family members and close friends. Invariably, it’s a car loan or a personal line of credit. While they’re not asking you directly for the money, there could be some financial repercussions down the road if they default on that loan — and drag your credit score down in the process.

Once your credit score drops due to their inability to make payments on the loan, it will be YOUR problem when you need credit.

The one (and probably only) thing that my father would never do for us kids is co-sign a loan. And we can’t blame him. Any financial sins on our part would drag him down with us — a missed payment on a loan account negatively affects ALL co-signers. The creditor doesn’t care who is “in charge” of paying the bill; they just want it paid. ON TIME.

A loan is a legal contract — not something to be trifled with.

Is There a Solution?

If you really want to help out your family member or friend financially, you can do one of two things — or both!

1) Loan them your own money for the purchase. But instead of risking your credit score, you’re now risking your hard-earned cash. There’s no guarantee that you’ll ever see any of that money again, although that’s the pessimistic view. To help insure this “investment,” have a lawyer draw up a simple loan/payback agreement so it’s on paper. That way, if things go awry, you may have some legal recourse. While you might get your money back, you’ll likely become estranged from whoever you’ve loaned the money to.

2) Help them improve their financial situation — and their credit score. If their score is too low to qualify them for the loan, there’s a more pressing issue to address: A craptastic credit score. That’s what is really holding them back. Instead of sacrificing your high credit score, help them figure out what they can do to improve their own. Perhaps it’s debt overload, or they’re a chronically-late bill-payer. Either way, they’ll need to repair their finances. Learning financial responsibility can only help them in the long run.

Have you had family or friends put you in this position before? How did you handle it when they asked you to co-sign a loan?

5 comments to Why Co-Signing for a Loan Isn’t a Good Idea

  • I wouldn’t cosign a loan for a car, but if my little sisters ever need a cosigner for their first apartment or something and my parents have passed away or are unavailable for some reason, I’d help out. They are both super responsible people and I remember I needed that sort of help right out of college since my credit history was almost non-existant…of course, my parents would probably volunteer first if they could, so I will probably never be in that position. 🙂

    • Oh, and if they needed a car loan or something like that, I’d just lend them the cash. I seemed to have left that part off. Even my husband thinks my little sisters are two of the most repsonsible people we both know and they are just 15 and 20!

  • Chris

    I needed a car, my first, when I graduated from college. I had no credit card, and had no credit history at all. My friend, who had been working been paying rent, owned a car, and was more established, co-signed for me on a car loan. It was the most generous gift I could have ever received at that time in my life. It gave me the opportunity to commute to work and be independent after all those years of walking, biking and bussing…. I bought the car within my earning means; I did NOT deafault on the loan, and will be forever grateful to my friend.

  • I have been in the position of needing a cosigner. My last semester of college, some financial aid did not go through. I applied for a grant but would not find out about it until very close to the tuition due date. As a back up, I applied for some alternative student loans but needed a co-signer. At this point, my only other alternative was to drop out my last semester. So I asked my much older siblings if any of them could co-sign for me so I could graduate. They all refused. It really sucked for me at the time but now I do understand their point of view and really can’t blame them. In the end it did not matter because the grant went through anyway.

    • Nicole

      @Leslie: Glad it came through at the last minute. I think a school loan might be the only exception for me, since it will pay off in the end (you hope!).