Unfortunately, it’s not simple. Before you sign on the dotted line, here are a few things you should be aware of.
There’s probably a reason your friend or relative has bad credit
There are just a few reasons a person can’t get a loan on their own—they already have too much debt, they don’t make enough to cover their expenses, or they have a history of not paying bills on time. Unless your friend or relative went through a one-time financial hardship and is still waiting for their credit score to recover, odds are good that their poor money habits are the real problem.
Instead of throwing your money after theirs, offer to help set them up with a secured credit card (where you pay a fee upfront to use as collateral). It’s a lot less risky for you and helps them re-establish their credit.
You’ll be on the hook for payments
Cosigning a loan makes you just as responsible as the primary borrower for the full balance of the loan—late fees and interest included. That’s not all, either. Most people assume that the lender must first do all they can to get the money out of the borrower before they move onto the cosigner. In many cases, though, the lender may take action against the cosigner first.
The logic here is pretty simple. They know the cosigner is the one who’s good for the money, so why bother with the primary borrower?
Cosigning a loan can make relationships tense
Once you throw your financial reputation in with a relative’s, it’s in your best interests to make sure they’re being responsible with it. This can add a new dynamic to a relationship, one that’s not always welcome.
It can keep you from taking out your own loans
When you apply for financing for a major purchase like a home or a car, lenders take into account something called your debt-to-income ratio, or DTI. Basically, that’s the amount of debt you’re currently carrying weighed against the amount of money you bring in. When it’s too high, lenders will reject you - and any loan you cosign will be counted as your debt.
That means that if you’re hoping to get a mortgage over the next few years, cosigning someone else’s loan could put your dream at risk.
The bottom line?
If you wouldn’t give your relative the money for their loan outright, then it’s not a good idea to cosign their loan. Though this may cause some disappointment and resentment in the short term, ultimately, it’s the smart decision for both your personal finances and the health of your relationship.