I saw the results of a survey the other day that didn’t surprise me but may surprise you.  The study found that four out of 10 people who co-signed a loan got burned.  Thirty-eight percent of the co-signers had to pay off the loan or the credit card bill.  The reason:  the primary borrower did not meet their obligations.  Twenty-eight percent saw their credit scores decline because the primary borrower was either late in their payments or did not pay at all, and 26 percent said their relationship with the person they co-signed for had been hurt.  The bottom line, co-signing can be dangerous.

I am frequently asked by clients and others about whether they should co-sign a loan or not.  Whenever I’m asked that, the first thing I remind people of is their legal obligation.  When you co-sign a loan you are as responsible for the loan as the person you are co-signing for.  Therefore, if they don’t make the payment, you are responsible for it.  If they are late on a payment, it could impact your credit scores and future borrowing ability.  What sometimes confuses people is they assume if the primary borrower defaults on the loan, the lender is going to go after that person first.  It doesn’t work that way.  The lender can choose to come after you.  Remember, from the lenders standpoint, you are both responsible for the loan.  In fact, if the primary borrower ends up in bankruptcy, that may relieve their obligation to the lender; it doesn’t relieve yours.  You are the co-signer and therefore, you are ultimately responsible.

Whenever someone asks you to co-sign a loan, it’s obviously a difficult position to be put in.  After all, more likely than not the person who is asking you to co-sign the loan is a very good friend, a child or a relative.  Therefore, you’re initial instincts are always to say yes.  However, it is important to consider your legal and financial obligations before you get involved.   My general rule is that if someone asks you to co-sign a loan, you should make the assumption that ultimately, you will be responsible for that loan.  Therefore, if repaying that loan is going to put you in financial difficulty, you probably should decline.  I know that is difficult to do; however, it is the responsible thing to do.

If you decide to co-sign on a loan, my recommendation is that you sit down with the primary borrower to make sure they understand their obligation, what impact late payments and non-payment will have on you, and what you expect from them.  In addition, I would work with the lender to make sure if there is any kind of default, you are immediately notified.  I would also make sure you have access to the loan account online so you can independently verify that the loan is being repaid on time.

Before you agree to co-sign a loan, it is important that you dot the I’s and cross the T’s.  Don’t rush into this arrangement; be certain  you’re going into it with your eyes wide open.  In addition, don’t forget you want to confirm that the primary borrower has the resources to repay the loan.  If the person has a history of not repaying their loans and they are in shaky financial shape, co-signing a loan can lead to disastrous consequences.

Good luck!

Rick is a fee-only financial advisor.  His website is www.bloomassetmanagement.com.  If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com.