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Cosigning for a loan? Be careful!

Posted: March 7, 2011

A friend asks you to cosign a loan for him. He tells you that you’d be doing him a really big favor if you would. But while it would be great for your friend, it could end up being disastrous for you.

A young woman in a class I taught told me she found an error on her credit report. It said that she had a car loan for $5,000. But she said the loan wasn’t hers. She had co-signed on the loan for her boyfriend. In the meantime, her boyfriend was killed in Iraq. The car wasn’t hers. She said she had no obligation and would not repay the loan. What she didn’t realize was that when she cosigned for the loan, she had guaranteed its repayment and that the loan and the payment history would go on her credit report. Fortunately, the she was able to resolve the situation. But she had experienced some intense anxiety in the meantime.

Before cosigning for a loan, make sure you know what is involved so you can protect yourself and your own credit reputation. When cosigning on a loan, you are guaranteeing the repayment of the loan. The lender has already refused to lend to your friend based his credit record. That’s why he’s asking you to cosign and to guarantee payment. The risk of your having to make the payments yourself is high. Of those loans going into default, as many and three out of four cosigners are asked to repay the loan according to various studies.

Want to cosign anyway?

There may be times when you may want to cosign. It can help your child get his/her first loan. You may want to help a close friend. Before you cosign, however, ask yourself several important questions.

  • Can you afford to pay the loan? If not, you could be sued or our own credit rating could go down the tubes.
  • How will your credit report be affected? Even if you aren’t asked to repay, that debt is on your credit record and may keep you from getting other credit.
  • Will it be a secured loan? If so, you risk losing the property used to secure it if the borrower defaults.
  • Will you get an early warning if the borrower is late or behind in the payments? Ask the lender to agree, in writing, to notify you if the borrower misses a payment. This will allow you to deal with the problem by making any payments due without having to pay the entire amount had it gone into default.
  • Will you get copies of the relevant documents? Ask for copies of all important papers related to the loan including the loan contract, Truth-in-Lending Disclosure Statement, and any warranties involved. You may need to get these documents from the borrower as the lender isn’t required to provide them to you as the cosigner.
  • Lastly, would you be willing to take the loan in your name instead and just hand over the cash to the person asking to cosign?