If a friend or family member comes to you asking if you would cosign a loan for them, give these five questions some hard thought before saying “Yes.” There is more to cosigning than just putting your signature on the borrower’s loan documents. Although it may be hard to say no to a friend or relative when they are in dire need of a cosigner, many cosigners later wish they had the courage to lovingly say "No." According to a survey by CreditCards.com, almost 40% of cosigners find themselves paying for other people's loans because the primary borrower has defaulted.1
However, cosigning doesn’t always end badly. Here are five crucial questions to ask yourself before putting pen to paper – if you want things to end well.
1. What Exactly is Cosigning for a Loan?
You must first understand the legal obligations of cosigning to be on the right path. When you cosign a loan, it means that you are guaranteeing someone else’s debt and you will be required to repay the debt if the borrower fails to make the payments. It doesn’t matter whether you benefited from the loan or not – basically, it’s your loan, too. You need to be sure that you can afford to pay the debt if you are required to, up to an including the full amount if the borrower never makes a single payment. It’s also good to note that if the debt is in default; your credit record may be adversely affected.
2. Who Is the Borrower to You and What is the Purpose of the Loan?
It is important to examine your relationship with the borrower and determine what they are planning to do with the loan before co-signing on it. Are they a student looking for college education fees? Are they a friend who wants to buy a car or apartment? Do they want to start a business?
In all cases, it is possible that unforeseen circumstances could arise and make it impossible for the borrower to repay their loan. A student could drop out or finish their education and fail to get a job, leaving you with thousands of dollars worth of debt. Your friend’s business could fail to take-off and make them miss payments. There are so many scenarios that could lead to a borrower failing to make their payments on time. So, cosign only when you can afford to take on the entirety of the debt.
3. Why Does the Borrower Need a Cosigner?
You are entitled to ask questions about why the borrower needs a cosigner. You need to understand their financial history and money habits thoroughly before agreeing to cosign. Find out their level of discipline in making timely payments, managing their finances, and maintaining a healthy credit score. Also make sure to ask about their employment history and current financial status (income, expenses, credit, etc.) That may be an uncomfortable conversation to have, but it’s critical that you have a thorough understanding of their finances before taking any risks.
4. Will You Be Able to Reach Your Other Financial Goals While Cosigned for the Debt?
If you are planning on applying for credit yourself or refinancing your home in the near future, it would be best that you don’t cosign any loans now. In the eyes of a lender, a loan that you have cosigned is part of your total debt, and hence it may be hard for them to extend you additional credit until it’s fully repaid.
5. What Would Happen to Your Relationship With the Borrower If They Default?
According to Forbes, 26 percent of individuals who cosigned loans ended up with a damaged relationship with the borrower, following a default.2 As mentioned earlier, cases of default are rampant – with around four in every 10 people defaulting and leaving repayment of the debt to the cosigner – and hence it’s important to decide if you are ready to sacrifice your relationship with a friend or family member if they fail to pay.
If you are thinking of cosigning for someone, make sure both of you understand the process in detail to safeguard your finances and relationship.
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