Co-Sign A Loan: What You Need to Know

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Co-signing a loan can be a great gift for a friend or relative who would not otherwise be able to secure a loan. But, it comes with very serious risks as well. Here’s what you need to know before you co-sign a loan.

Banks and other lenders consider those with bad or no credit history to be a risk and may not approve loans for cars, homes or other items unless someone with good credit history cosigns the loan. If you’ve been asked to co-sign a loan for a friend or family member, you need to weigh the risk you are putting on yourself with the reward you are providing for those you care about. Before you sign that dotted line, be prepared for all “what if” scenarios that could occur.

What if a payment is missed on the loan?

In most states, the lender can try to collect payment from you first, without even trying to receive funds from the borrower. The lender wants to collect payment and is likely to go to the borrower who is most likely to pay the fastest. And you, with the solid credit history, are the best match. In addition, you may end up paying fees on top of the money owed to cover late charges, or attorney fees if the lender decides to sue.

What if the borrower defaults?

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Life happens—people lose their jobs, get sick and suffer unexpected injuries. Your friend or relative may find themselves in a position where they are no longer able to pay on the loan that you have co-signed. If this happens, the lender will expect you to pick up the payments. If you don’t, the lender can sue you for payment or force you to sell your car, home, or other belongings to pay the debt.

In addition, the lender will notify the credit bureaus of the loan default, which could end up hurting your credit score. This could hurt your ability to secure loans in the future and could even cause lenders to raise interest rates on your existing balances.

What if I need to secure a loan?

You may find it more difficult to secure a loan for yourself while your name is attached to someone else’s loan. Any loans you’ve co-signed for are seen as your own by lenders and are included in your credit report and factored into your debt-to-earnings ratio.

What if I need to take my name off a co-signed loan?

Whether the borrower is struggling to make payments, you need to secure a loan for yourself, or you no longer want the responsibility of shared credit, it is possible—although not necessary fast or easy—to remove your name from a co-signed loan. You and the borrower could refinance the loan, moving it under the sole responsibility of your friend or relative. You could work with the borrower to improve their credit rating. Or, you can ask the borrower to make extra payments to pay the loan off faster. And, if you are a joint account holder on a credit card or line of credit, you can close the account. (Although you will need to pay off the remaining balance first.)

If you still want to co-sign that loan…

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If you have considered all of these scenarios and still want to co-sign a loan for a friend or family member, there are some measures you can take to protect yourself.

  • Ask the lender to calculate the amount of money you might owe.
  • Ask the lender to agree, in writing, to notify you if the borrower misses a payment.
  • Ask the lender if you can limit your responsibility to the value of the loan itself, and not late charges or other collection fees.
  • Ask your friend or relative to sign a promissory note for the amount you’ve paid on the loan, and set up a schedule for repayment.
  • Make sure you get copies of all important papers.
  • Check your state law for co-signer rights.

This article contains general information. Individual financial situations are unique; please, consult your financial advisor or tax attorney before utilizing any of the information contained in this article.

Source: Federal Trade Commission, Bankrate.com, Lawyers.com, MSN Money, Forbes.com
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