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Co-Signing a Loan: The Good and The Bad
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Co-signing happens pretty frequently in the world of lending and loans, it’s a way for someone with better credit to help someone who struggles with their finances and credit. This practice is most common among close friends and family members as it requires a good relationship with lots of trust.
There are mixed feelings about whether or not co-signing a loan is a good idea, the root of the issue is of course that people don’t really understand what co-signing a loan entails. Like most financial commitments understanding all the risks and benefits is the best way for you to make the right choice. Here is the good and the bad when it comes to co-signing a loan.
What does co-signing mean?
Simply put co-signing means that you are helping another person who can’t get a loan, get a loan. You’re putting your name and credit history onto someone else’s loan, thus making yourself responsible for their loan in the same way that you would be responsible for your own loan. Because of past financial mistakes or bad credit scores people sometimes cannot qualify for a loan, this is where a co-signer would come in. A co-signer uses their “good” credit history to help a friend or family member get the loan they need.
1. It helps a friend or family member obtain financing.
There are countless reasons why taking out a loan is a good idea; school, transportation and housing are just a few. If the availability of a loan is taken away then some people’s options become very limited. Being rejected for a loan because of poor credit is a reality that many people have to deal with but a co-signer could help them change their financial situation. Co-signing a loan could help someone you know go to school, get a reliable car or move to a better location.
2. Helps build credit for both signers.
In order to build your credit score you need to get credit which can be difficult for people who have a bad financial history or no history at all. This is where a co-signer can be beneficial. Someone who has a good credit history can co-sign a loan to help a person with bad credit and therefore help them build their credit.
Furthermore, since the person who is helping is attached to the loan in the same way as the primary signer, their credit score will also benefit if the loan payments are made on time and loan is paid off on time.
3. Better interest rates.
Unfortunately people with bad credit scores and history have to pay higher interest rates because they are seen as high risk by lenders. But if they are able to get a co-signer who has a good credit history they will benefit from that person’s credit strength and therefore be offered a more manageable interest rate.
4. Avoid predatory lending practices.
By getting a co-signer you can avoid predatory lenders who prey on those looking for a loan but have bad credit. Predatory lenders are looking for vulnerable people to take advantage of by not clearly explaining the terms of the loan and asking for extremely high interest rates. Having a person with good credit co-sign your loan will allow you to be eligible for a higher quality loan from a lender who is not looking to take advantage of you.
1. You will get no “material” reward.
This is the most obvious reason why co-signing for a loan, a car or even a mortgage could be a bad idea. There is no “material” benefit to you, you won’t get to drive the car or live in the house but you’ll be responsible for the payments. If the person you’re co-signing for is unable to make a payment then it will be up to you to pay it.
2. You are responsible for the loan.
If you co-sign a loan with someone you are technically the only reason they are able to get the loan. Your good credit score and history is why your friend or family member with a bad credit score and history is able to get a loan.
If the payments stop being made then the person with the good credit, which is you, will be held legally responsible because you are more likely to be able to pay off the debt.
3. You could be rejected for a loan you need in the future.
Co-signing a loan now could make it impossible for you to get a loan if and when you need one. Think about your future carefully before you decided to co-sign a loan. You might not think you’ll need a loan in the near or even distant future but you never really know and you don’t want to be rejected if the time comes.
4. You will have to make the payments.
Prepare yourself to make the payments no matter what. Since you have taken on the responsibility of being a co-signer you need to protect yourself and your credit score. Put aside some money just in case the other signer defaults and be prepared for the worst.
5. You will have to keep track of the payments.
Even if your friend or family member promises they are making the payments, you will still need to check for yourself. Simply putting it to the back of your mind and not checking up on them every month will not be an option. You will have to treat it like all of your other monthly bills and stay organized and on top of it.
Wanting to help out a friend or family member is never a bad idea but when you’re asked to help them out financially you should think carefully about the consequences. Depending on the situation the good can outweigh the bad but the bad can also outweigh the good. The best idea for both parties is to have the best understanding of what co-signing a loan really means, that way if you have the opportunity to help out a friend you’ll be able to say yes with confidence.
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