The ability to cosign a loan is one of the most popular options when it comes to borrowing money without having to have a great credit score. Although creditors initially came up with this possibility in order to enable groups of people to loan money, this type of agreement is now used to help those with a low credit score borrow money when then need it. Unfortunately, this financial decision can also be extremely risky, especially if you are the one who is helping someone with a bad history when it comes to debt.
This having been said, although cosigning is meant to help everyone, regardless of credit score or bank relationship, get a loan, it does come with serious risks, for all parties involved. Depending on the type of loan that you cosign, you may find that your own financial affairs will be seriously affected. Here is what can go wrong when cosigning a loan:
If the borrower has a history of handling money badly
Cosigning a loan is a very serious decision, especially if a lot of money is involved. You are essentially putting your entire financial reputation on the line to help another individual that may not be eligible for a loan. In most cases, the ones that are usually turned down by banks are those who have a history of bad debt.
You should not take this detail lightly. If you want to cosign a loan with someone who has a low credit score, make sure that the individual is serious about repaying the loan and that he has the income necessary to do this. Otherwise, you may put yourself in a situation where you will have to pay off another individual’s debt.
Make sure that your cosigner does not have large, standing debts from his past and that he has always repaid past loans.
If the borrower has no experience when it comes to managing money
When it comes to cosigning a loan, the most widely encountered scenario is that of parents helping their children borrow money. If your kids or other young family members have never taken out a loan or made financial decisions to help them build up their credit score, you should be cautious.
Depending on whether or not they have a stable source of income, it may be better to take out the money yourself, through a personal loan and then give it to them. This may not help them build up their score, but at least they won’t be stuck with bad credit.
Regardless of the situation, always make sure that whoever you cosign the loan with is able to manage both the money that he borrows, as well as his income. In other words, only help those who you know can actually repay the money on time.
If you intend to also take out a loan for yourself
Lastly, if you want to take out a loan, of any type, you should avoid cosigning. Keep in mind that the monthly payments for a loan that you cosign are still considered your responsibility. Any cosigned loan will affect your debt-to-income ratio. This may lower your chances of getting approved for other types of loans. You can cosign a loan, even if you want to borrow money personally, however, you should do the math and figure out how much your debt-to-income ratio will be affected.
You should also consider the fact that if your cosigner cannot repay the money, you may be left having to make his monthly payments, while also taking care of your personal debt. This can put a huge strain on your finances.
Generally speaking, you should only agree to cosign a loan with someone that you trust and know for at least a couple of years. Cosigning means that you will have to make the monthly payments for the loan if the one benefiter is unable, regardless of the reason. This makes it important to not only to trust the individual that you intend to help but also that you know his or her financial habits, especially when it comes to handling income and debt.
It is also a good idea to make contingency plans, in case the benefiter cannot repay the loan. This means doing the math to figure out how the monthly payments would fit in your budget. Failure to return the money will not only affect the benefiter but will also cause your credit score to drop and do long-term damage to your financial track record.
As a rule of thumb, only cosign loans that you know that you can pay without putting serious strain on your finances, and only do so if you’re certain that the benefiter will repay it.