Considering co-signing a loan for an adult child who needs a car, a student loan or a credit card?
You may want to brace yourself for the relationship fallout that could come down the road if he or she stops paying on the obligation — a debt that has your name written all over it!
And that only scratches the surface when it comes to the potential financial damage of cosigning on a loan.
Co-signing a loan can strain relationships
Nobody likes to think about it, but you have an almost four in 10 chance that you’ll be the one who has to pay when you co-sign a loan. That’s according to a CreditCards.com survey that found 38% of the 2,000 adult co-signers they asked were making the monthly payments because the primary borrower was not.
Even worse, that unexpected turn of events led to a breakdown in relations between co-signer and primary borrower about a quarter of the time — 26% to be exact.
On the question of lending money to family and friends — separate from the co-signing issue — Clark has long had two rules.
One, treat it as a one-time only thing. And two, treat any money you lend as a gift, rather than as a loan. That way if you do actually get paid back, it’s a happy surprise!
Co-signing a loan is dangerous to your financial health
Some 17% of Americans have co-signed a loan for a child or someone else, according to CreditCards.com. The most common type of co-singings are a parent co-signing an auto loan for a child. That represents about half (51%) of all the co-signing action, followed by personal loans (24%), student loans (19%) and credit cards (16%).
According to a 2012 report by the Consumer Financial Protection Bureau and Department of Education, about 90% of all private student loans are co-signed by a parent. Sadly, a 2014 Citizens Financial Group survey revealed that 94% of parents with a child in college said they felt more burdened due to their children’s college loans. In addition, around 50% of parents did not have a plan to repay their child’s student loan debt.
When you co-sign a loan, you’re doing more than just giving a character reference for the person. You’re agreeing to pay the debt if they welch on payments — either intentionally or because they lose a job and can’t find another.
So co-signing a loan creates a long-term financial obligation. It is a hazard that should be avoided if at all possible.
More tips to keep in mind
Co-signing a loan will raise your debt-to-income ratio. This can really hurt if you’re applying for a mortgage. Clark has long said you shouldn’t go out and get a loan for a car in the months before you plan to buy a home. But your credit score is still at risk if you’ve co-signed a car loan for somebody else.
It may be possible to remove yourself as a co-signer. With private student loans, you may be eligible for a co-signer release once the person you signed for makes a certain number of consecutive on-time payments and has a credit check. But you’ll likely have to stay on the student loan servicer to make this happen. With an auto loan, you can sometimes get off as a co-signer if the person you signed for refinances the loan in their own name.
You may be able to negotiate terms of co-signing beforehand. The Federal Trade Commission suggests that you try to get the following language in the contract: ‘The co-signer will be responsible only for the principal balance on this loan at the time of default.’ That means you won’t be responsible for late fees or court costs if you’re sued over the debt because the borrower is not paying as agreed.
Your untimely passing could throw the borrower into immediate default. Private student loans commonly contain a clause that lets the lender call the loan due in full if you as a co-signer die or declare bankruptcy. The CFPB is recommending people in private student loans try to get a release for their co-signer before something like this happens. They have a series of sample letters to help you get the job done.