One of the absolutely most risky financial decisions you can make is to cosign a loan for someone.
The FTC has even done research to show consumers exactly how atrocious of a decision cosigning a loan is. It can be really hard to turn down the need to cosign a loan; usually the person asking you is a relative or very close friend. They are promising that it won’t be a big deal and they’ll be able to pay on time.
But is that true?
Should you ever cosign a loan?
The Risks of Cosigning a Loan
Here are three risks of accepting the offer to cosign a loan.
The Person Asking is a Credit Risk
The only time someone ever needs another person to cosign a loan is when the financial institution has determined they are a credit risk. Whether due to their past credit history or a lack of income, the lending institution has determined it can’t afford to risk lending that person the cash.
Does it make sense for you to take on that kind of risk if an institution that is solely in business to lend money won’t?
Think about that again.
The bank is in the business of lending money for profit. They are saying no based on that person’s credit history and income.
Obviously you aren’t directly lending the money by just lending your credit profile to the application. But you may end up paying the bill at the end of the day; you would be directly lending the money to the now non-paying person by then.
Protecting Your Credit History
The reason your signature (and officially signing up to pay the obligation if the other person fails to pay) is needed is because you have the strong credit history, income, or both needed to qualify for the loan.
When you sign on the dotted line you put all of that credit history and income at risk.
If the person you are cosigning for defaults on the debt — which they’ve proven capable of doing in the past thanks to their poor credit history — then you end up bearing the burden.
Even worse the cosigned loan will show up on your credit report and impact your ability to acquire credit in the future even if the loan is paid on time. You are using up some of your available credit based on your income for something that isn’t even benefiting you.
Protecting Your Relationship
The person asking you to cosign a loan is putting your relationship with them at extreme risk just by asking.
It isn’t fair.
You are instantly put in an awkward position.
Do you say no immediately — since that is the smartest financial decision — and end up hurting their feelings or having them get upset with you?
Or do you say you will think about it, hoping they will ask someone else, and end up with the same result of hurt feelings?
Or worse, do you accept the offer to cosign the loan and put yourself in a horrible financial position?
None of the above are good, and all they did was ask a simple question. It puts you in a really sticky situation and frankly, isn’t something that a true friend or relative would ask you to do.
The Positive Side of Cosigning a Loan
This will be brief.
The only positive to cosigning a loan comes from having another loan on your credit history that is paid on time and eventually paid off. This builds up your history and shows you are a safe credit risk.
That is the only positive in this situation. And it likely comes at the cost of you paying off the loan, and not the person needing you to cosign.
How to React to a Cosign Request
Just because someone puts you in an awkward position by asking you to cosign a loan doesn’t mean you can’t or shouldn’t help them.
You just shouldn’t help them by putting your own credit at risk.
Here are a few things you can try instead of cosigning a loan. It depends on what they need the loan for, but let’s use an automobile as an example:
- Offer to talk with them to get to the root of the financial issue as to why they can’t buy a vehicle of their own. Is it due to wanting too nice of a vehicle versus something to get them from Point A to Point B? Are they unwilling to try alternatives like public transportation?
- Offer to give them money to help out (essentially you are giving them money by cosigning because if they fail to pay, you end up paying) in order to buy something that will meet their minimum needs. In this example, a beater car that simply goes from Point A to Point B.
- Offer to help them get to and from work while they save up money to buy a vehicle on their own without a loan.
The things you can do to help out will depend on what they are using the loan proceeds for. Saying no to the loan cosigning request isn’t saying no to helping in general.
Never put yourself at financial risk to help out someone that can’t get a loan on their own. Remember, there is a reason the bank said no to potential profits.