Thursday, May 7, 2009

Before you co-sign a loan

A long, long time ago a certain relative (no names, you know who your are) asked me to co-sign an auto loan and I said, "no".

I felt cruel and heartless. This person was desperate. She needed a car to get to her job. But she didn't have a credit history and couldn't get a loan. There were tears, but no blame.
Why did I say no? Because I knew this person. I knew how badly she handled money. More than that I knew that I couldn't afford to take on another car payment, which might happen if (or more likely when) she defaulted on the loan.

As a loan co-signer you agree to ensure that the loan will be paid back. The lender doesn't really care who pays it, as long as it's paid. If the primary borrower defaults or skips town, you're likely to be held liable. Typically, the lender can come after you first, without trying to collect from the borrower. And so, you could:

  • be required to pay late fees or attorney fees.
    have your wages garnished.
  • lose any property you put up as collateral

Not only that but your credit score could be affected by the primary's default or late payments. And if you are planning on a purchase such as a house or car for yourself in the near future this co-signed loan will appear on your credit history.

Before you agree to co-sign on any loan review the situation.People only need a co-signer for one of two reasons: 1) they do not have a credit history, or 2) they have really poor credit.

If the person you know falls into the first reason think about how well you know them. The loan already creates a legal agreement that they are expected to make payments, but do you think they have the capacity to do so? Do they have a job? Do you have any reason at all not to trust them?

For wannabe borrowers who fall into the second category of poor credit, do you know how they got there? How long have you known them? Instinct should tell you if someone is a high-risk.

To protect yourself you can do what I did and just say, "no". Or, you could try asking the lender to write an agreement into the loan stating that you would only be responsible for the balance of the loan at time of any default. This could save you legal fees later.

Don't get me wrong. Co-signing isn't all bad. If you know someone who is young or recently divorced they may not have an adequate credit history. Your co-signing can help them begin to build credit--which is important as they continue in their life.

As for the one that I said "no" to--She got a car the old fashioned way. She continued to borrow a car to get to work then saved enough to buy a used car. It wasn't as pretty as the brand new car, but it worked great and I think it helped learn some financial discipline.

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