The Consequences of Cosigning Your Loan

October 15, 2008

If you have lower-income family members or friends, or younger family members just starting out life on their own, chances are, at some point, you’ll be asked to cosign a loan. Perhaps, you yourself have at one point or another found yourself in the position of having to ask for well-off friend or family member to be your cosigner.

The fact is, many agreements involving large sums of money–agreements such as financing with an auto loan, or renting an apartment, acts necessary for independent life–require levels of income or credit histories that many people don’t actually possess. Someone who doesn’t qualify for that apartment lease or vehicle loan on his or her own may be able to do so if a trusted friend or family member acts as cosigner.

This good-faith assistance from one’s nearest and dearest can provide low-income individuals with exactly what they need to “move up” in life. However–tempting as it is to do so–don’t automatically agree to cosign a friend or family member’s loan. Thoughtlessly cosigning someone’s loan could land you in a heap of trouble.

Cosigning a loan means that you’re guaranteeing the debt that the borrower is assuming. In essence, you and your assets are acting as security for the loan. If that friend or family member you’re cosigning for fails to pay the full balance of the loan–perhaps through no obvious fault of their own–the lender has full license to pursue you to pay the difference.

Furthermore, if the borrower defaults, you won’t only be left having to pay the balance. You’ll also have to pay all the interest that the debt has collected over the years, plus all late fees, lawyers’ fees (if the lender sees fit to hire a lawyer), and any collection agency fees that may accrue. You’ll be receiving calls in the middle of the night from collection agents. You could be sued.

What’s worse is that, unless your state has laws that explicitly prohibit this, the moment the borrower fails to make his or her regular payments, the lender will probably try go after you first–without even letting the borrower know what is happening. The Federal Trade Commission’s statistics reveal that cosigners end up having to pay the entire leftover balance, plus any associated fees, of 75% of all defaulted cosigned loans.

Additionally, your friend or family member’s failure to pay his or her cosigned loan will negatively affect the cosigner’s–your–credit score. This, in turn, will negatively affect the rest of your finances, as you, in turn, will no longer be able to qualify for the lowest-interest loans. Plus, you may end up having to pay higher premiums on home and vehicle insurance.

In conclusion, before you cosign a loan, be absolutely certain that the borrower has the means to pay it off. Don’t cosign loans for friends and family members without a good, solid reason–besides the emotional reason than that they are your family member or friend. Otherwise, you could end up with the kind of debt that will do more than harm you financially. That debt will put on severe strain on the once-trusting relationship between you and the borrower.