As parents, we all want to help our kids get the best possible start in life. We feed and clothe them, we make sure they get a quality education, and when the time comes we do what we can to help launch them into the adult world. But there are limits to what we can and should do. For example, it may be very tempting to agree to co-sign a car loan or credit card application for a child – or for that matter, for another family member or friend who is having financial challenges. This is not always a good idea, and in fact can be a very bad one, depending upon the circumstances. However, there may be other alternatives to explore if someone really needs your help.
Think carefully before co-signing on a loan
There are a few fundamental questions you need to ask yourself – and answer honestly – before agreeing to co-sign a loan, even for a family member or dear friend. They are:
Can I afford to repay the loan myself? – The hard truth is that well over a third of all co-signers end up paying at least part of the loan due to the borrower being late on payments or missing the payment(s) altogether. This often puts the co-signer in a financial bind, and in more than a quarter of the cases studied, the co-signer’s credit scores were negatively impacted as a result. Are you willing and able to accept your contractual responsibility for repayment?
Do I trust the person to live up to the terms of the loan? – If the borrower has failed to live up to his or her own previous agreements, is there sufficient reason to believe that he or she will behave differently this time? Regardless of the borrower’s good intentions to live up to the agreement, good intentions don’t pay the bills. You need to consider that the lender might have good reason not to lend money to the person.
Will co-signing the loan help the person out of an acute situation, or merely enable their poor choices? – If the person is facing a unique challenge, such as an unexpected expense or an expense that can offer a significant benefit to the borrower’s well-being, such as a car loan or student loan, co-signing a loan can help them build or maintain a good credit record. But if the situation is just another in a long line of the borrower’s bad choices, co-signing a loan for him or her can serve to relieve them of the need to accept responsibility for their actions.
Know the difference between being a co-applicant and a co-signer
It is easy to see how some people might tend to think of “co-signer” and “co-applicant” as two different terms for the same thing, but there is a significant difference between the two, and it is a difference that can have significant ramifications for the “co” party.
A co-signer simply vouches for the borrower’s promise to repay the loan, and if the borrower lives up to the terms of the loan agreement, the co-signer doesn’t really get involved beyond that voucher. If the borrower is late on a payment or misses one, the co-signer is contacted and required to make up for the missed or late payment(s). If the borrower demonstrates a pattern of non-payment, the co-signer may be asked – and is contractually obligated – to assume responsibility for full repayment of the loan. So long as the co-signer meets that responsibility, his or her credit score won’t necessarily be negatively affected.
A co-applicant, on the other hand, agrees to assume the role of full partner with the borrower, and assumes equal responsibility for full and timely repayment. If the borrower is late or misses a payment, or particularly if the borrower defaults on the loan, the co-applicant’s credit record, as well as the borrower’s, will take a negative hit. For this reason, it is essential that the co-applicant stay on top of the loan, and make certain that payments are not late or missed.
Another alternative for helping out your credit-challenged loved one is to be a guarantor. A guarantor is similar to a cosigner, but with one crucial difference: the guarantor does not become liable for the debt until the bank has exhausted all other means of collection from the primary borrower. This is a marked difference from either a co-signer or co-applicant agreement, in which cases the bank can immediately pursue both parties.
Even as a guarantor, look before you leap
Even though recovery of the debt is not immediate on a guarantor loan, the guarantor is still ultimately responsible for repaying the loan, and there are additional elements that the prospective guarantor needs to consider before agreeing to vouch for the borrower. If the loan amount is high, the bank might require that the guarantor provide proof of some form of a tangible asset such as a home. And in extreme cases, if the bank decides to call the loan due immediately, the guarantor could end up fighting to save his or her own credit rating.
The desire to lend a helping hand is admirable, but you absolutely must be aware of the risks involved in your choices. You’re not doing your loved one or yourself any favors if you compromise your own financial well-being in an attempt to help out.