Co-signing a loan can be like getting a hangover without first enjoying the buzz. There is no real financial upside for the co-signer, just a lot of risk. Even for the primary borrower, things may not end well. It can be a lose-lose arrangement for both parties.
Nothing is entirely black and white, but think of co-signing as a dark shade of gray. Occasionally it ends satisfactorily, but you might get better odds in Vegas.
What Is a Co-Signer?
A co-signer is someone with excellent credit who vouches for a credit-challenged borrower by guaranteeing a loan. The primary borrower piggybacks on the co-signer’s good credit rating.
The co-signer appears on the documents as the backup if the primary borrower fails to meet the terms of the agreement.
What Are the Benefits?
For the primary borrower, having a co-signer guarantee repayment means that he receives credit for which he would not have otherwise qualified. He ends up with cash, a car, furniture or a lease that he couldn’t obtain on his own.
Other than the satisfaction of doing something nice for the borrower, the co-signer doesn’t benefit at all.
What Are the Potential Downsides for the Borrower?
There is a reason that lenders insist that borrowers meet specific qualifications, such as a steady job and a reasonable level of existing loan balances, to obtain credit. Experience tells us that these qualifications are necessary for a borrower to successfully repay loans. When a lender extends credit to someone failing to meet the qualifications, odds are good that the borrower will begin falling behind on payments and perhaps even default. In the long run, this does the primary borrower more harm than good. It’s another black mark on his credit history, and securing credit the next time he needs it will be even more difficult.
What Are the Downsides for the Co-Signer?
The moment the co-signer’s signature appears on the credit documents, it’s his loan as much as the primary borrower’s. It will be reported to the national credit bureaus as the co-signer’s until it’s paid off. He is on the hook, and there is no going back. Because it’s listed on the co-signer’s credit report as his, it will increase his debt-to-income ratio, lowering his credit score.
What Are Other Potential Downsides for the Co-Signer?
A lower credit score for the co-signer is the one downside you can almost always count on, but there are other potential issues he may face, too. If the negative effect on his credit score isn’t enough to scare off a would-be co-signer, the array of other things that might go wrong should.
If the primary borrower is late with a payment, it will show up on the co-signer’s credit report, further lowering his credit score. The lender may begin calling the co-signer for the late payments. In the case of a complete default, the co-signer is 100 percent responsible. The lender may well sue the co-signer for the balance and other fees. In fact, the lender will likely sue the co-signer before suing the primary borrower. The co-signer’s excellent credit rating could be destroyed and require years to rebuild.
What it means to you: I was always taught never to lend money I couldn’t afford to lose. That’s ideal advice for anyone considering co-signing for someone else’s loan. Chances are, you’ll be left holding the bag. More often than not, co-signed loans leave nothing but wrecked credit ratings and ruined relationships in their wake.