A friend or relative has asked you to co-sign a loan, perhaps to buy a car or home, or for some other worthy purpose. You're told your signature is needed because he or she has no established credit record, or maybe there have been credit problems in the past. "Honest, all you've got to do is sign a piece of paper. I'll pay everything back. You won't owe a thing."
We can't tell you if co-signing a particular loan is a good or bad idea—that's a personal decision. But we will tell you that co-signing a loan can be risky. It means you are guaranteeing to pay the money back if the other person doesn't. And even though you may have great trust in your friend or relative, the odds say you may indeed be called upon to pay money.
The Federal Trade Commission says that as many as three out of four co-signers are requested to make payments on a loan. "When you're asked to co-sign, you're being asked to take a risk that a professional lender won't take," explains the FTC. "If the borrower met the (basic lending) criteria, the lender wouldn't require a co-signer" in the first place. In addition, the borrower may become unemployed or ill and no longer be able to repay the loan.
Unfortunately for the co-signer, the lender often looks to him or her soon after troubles start with a loan. "In many states, if the borrower misses just one payment, the lender can immediately try to collect from the co-signer without first trying to collect from the borrower," says Robert Patrick, an FDIC attorney.
And what could happen if you, as a co-signer, refuse to make the loan payments? You could get a bad mark on your credit record, and that could make it tougher to get a loan, a job, an insurance policy or something else you might apply for in the future. The lender can sue Even though you may trust your friend or relative, the odds say you may be called upon to pay money.
If you decide to co-sign a loan after all, we offer the following suggestions:
Before you sign on the dotted line: The borrower may not realize that when he or she is late with payments or misses a payment, that could tarnish your credit record. So, it's best to have an understanding (if not a written agreement) with the borrower that you will get early notice of any troubles, including late payments, so you can keep on top of the loan and work out problems with the lender before your credit record is damaged. Also, be sure you can afford to pay the loan, if you have to.
Be sure that the lender gives you a notice required by federal law before you agree to co-sign a loan. It explains your risks and responsibilities. (The fact that a lender didn't provide the required notice doesn't automatically excuse your debt as a co-signer, but it may help you in the long run. In some instances, for example, juries have decided that co-signers weren't liable for loan payments because they weren't advised of their responsibilities.) Ask the lender to estimate the amount of money you might owe if the borrower defaults. And, while a lender isn't obligated to do so, perhaps it would agree to limit what you'd owe in the event of a default. Such as, maybe you'd be expected to pay back the loan amount but not certain additional fees or costs. Be sure to include any limitations on your liability in the loan contract.
After you co-sign the loan: "Keep copies of all loan documents," says FDIC attorney Susan van den Toorn. "These records could protect you from excessive fees or penalties if the borrower defaults on the loan."
