What to Know before You Co-Sign a Loan

Clarity is always important when money is at stake

When a family member or friend asks you to co-sign a loan, it can be difficult to refuse. Of course you want to help, especially if it’s an adult child or grandchild making the request; you’d hate to risk hurting anyone’s feelings or worse yet, cause a family rift by declining. You may even think that co-signing is not that big a deal. However, it is a decision that should not be taken lightly, because if it doesn’t work out as intended, it can drain your savings and put a strain on your relationship.

Before you jump in to help, it’s important to understand the responsibilities entailed in co-signing a loan. A co-signer does not merely vouch for the other person’s credibility; she or he is held accountable for the full and timely repayment of the loan. In other words, if your friend or loved one is unable to pay the money back on time, you’ll have to pay it, and you will be charged with any late fees or extra charges that may apply. Additionally your credit will be dinged any time the borrower’s payment is late. And if you refuse to comply with the terms of the loan, the lender has the right to take legal action against you.

Sometimes co-signing works out beautifully, and you have the satisfaction of knowing you’ve helped someone in a meaningful financial way, but if the prospect of getting stuck with paying off your friend or loved one’s debt gives you the chills, take some time to assess the situation. Do you trust that the person will be able to follow through on repayment of the loan? If something goes wrong, can you afford to step in and repay the loan yourself? Would it wipe out your savings and compromise your retirement? Think of the worst-case scenario and play it out in your mind; you’d be surprised at how many co-signers end up paying for a loan they never actually wanted, so don’t take on more responsibility than you can handle.

Before you commit to taking the risk, have a serious talk with your family member or friend in order to learn more about his or her plans. Does this person have a history of following through on promises and keeping agreements? Have a savings account and make good financial decisions?

It’s also important to find out the total amount of the loan, how it will be used, and how the person intends to pay it back. There should be a budget and a sound repayment plan in place, and the borrower should sign an agreement to pay back any payments or fees you end up having to cover. If it’s a home mortgage, there should be assurance of the necessary income to cover not just the monthly payment, but also homeowner’s insurance, property taxes and any needed repairs. This is a business decision for you, so you’ll need to do your due diligence.

Explain to the person that once you co-sign, you are both equally responsible for this loan, and make an agreement that you will be immediately notified if he or she intends to skip a payment. If you are kept in the loop, you will be able to manage your finances accordingly and avoid late fees and other unpleasant surprises.

No matter how much you want to help your family member or friend get the needed funds, sometimes you just have to say no. If you are in an unstable financial situation, feel uneasy about cosigning or have a concern that you won’t be able to cope with the responsibility, it would be wiser to decline. Let your loved one or friend know why you can’t co-sign and help the person to understand that it is not a matter of trust.

Anyone who truly cares about your well-being will understand that there is a reasonable explanation for your decision, and will have no reason to hold a grudge against you. Most importantly, you will not have to lose sleep or financial security over a loan you didn’t want.