Be Cautious About Co-Signing a Loan

Co-signing a loan can be a blessing for the person you’re helping. It can also turn into your worst nightmare.

For those of you who are toying with helping out a partner, parent, sibling or child, don't do it by co-signing a note. Adding your name to someone else’s debt is a very serious financial step and could ruin your credit.

“You should never co-sign a loan,” says Lynn Brenner, a personal finance columnist. If the primary borrower gets behind in payments, “The bank will come after the person they have the greatest chance of collecting from. If they thought they had a good chance of collecting from your son, they wouldn’t have required a co-signer in the first place.”

A risk to your credit rating

When you co-sign a loan, you are signing a legal contract that holds you responsible for the entire debt, say consumer credit experts. If the borrower does not repay, it can be reported on your credit record. If it goes to a collection agency, the agency will try to collect from you.

But the bank can do more than ruin your credit rating. It can sue you and get a judgment against you for the amount of the loan plus interest. “You must go to court and disclose all your assets," Brenner says. “It can even force the sale of your house.” And, if the document is like most loan guarantees, it allows the bank to charge you its own legal fees in collecting the debt from you. A typical loan document is written in very small print on two sides of an 8" x 14" piece of paper.

“Very often people sign it without reading it, particularly when they want to help a child.  They assume that the lender will exhaust every means of collecting from the primary borrower before it comes after the co-signer. But the agreement typically allows the lender to decide who to go after,” Brenner says.

Collectors go after the person who offers the best chance of recovering the money. If a loan becomes delinquent, a collector can choose to call you, harass you, rather than your friend or relative, if the collector sees that you have a much better repayment record. Even if the loan is repaid on time each month, another lender may consider the amount of debt that you co-signed when determining if you already have too much credit. In other words, if you've added your good name to someone else's debt, it could be counted against you if you need a loan.

Be aware of the downfalls before you co-sign a loan.