When I first moved to Chicago, getting an apartment was a challenge. In order to rent a place to live, I needed to have proof of employment; however, in order to get a job, I needed to have proof of residence!
Thankfully, I was able to pick up a job as an independent contractor prior to moving and a family member generously offered to co-sign on the lease with me, so it all worked out in the end. Even so, I know firsthand how beneficial it can be to have a co-signer when you’re just starting out after college or trying to make a big change in your life.
While co-signing on an apartment only left my family member on the hook for the term of the lease, in other situations, co-signing carries a lot more risk. If you have a close friend or family member come to you asking to co-sign on their student loans, a car loan, mortgage loan, or some kind of personal loan, it’s easy to feel like you’re between a rock and a hard place. That being said, co-signing on a loan has some serious ramifications and may ultimately impact your own personal finance journey.
What does it mean to co-sign on a loan?
When you co-sign on a loan as an additional borrower, the lender sees you as a co-borrower on that new loan. That means that whatever the terms of the loan agreement are impact you and your debt-to-income ratio
as much as they do the primary borrower. If you’re looking into buying real estate or want to refinance your home, that debt is shown on your credit report and ultimately affects your credit score. This can make it difficult to achieve your own personal finance goals—even if the primary borrower makes regular payments on time without fail.
The pros of co-signing
While co-signing on a loan definitely has some serious risks associated with it, there are certain situations where it can be totally reasonable to co-sign on a loan with a friend or loved one. For example, younger people fresh out of high school or college likely have limited credit history and can thus have a bad credit score. If you’ve got good credit, co-signing with someone on a credit card or small loan can help them kickstart their financial journey, ultimately qualifying them for better interest rates and other financial products in the future.
If you’re trying to build your credit, there could be some scenarios where co-signing on a loan improves your credit score, too. In this sort of situation, co-signing can be a win-win for both parties, as long as you trust that the person you’re co-signing with is fully capable of tending to the loan the same way you would. When you have the same financial stability and values as your co-signee, there’s a lot less risk associated with co-signing on a loan—assuming it’s not for an exorbitant amount that will negatively impact your debt-to-income ratio.
All of that being said, co-signing generally has less of a benefit for you personally than it does for the person you’re signing with. As such, you should always think about co-signing on a loan as an act of generosity rather than a financial move to pull out of your own personal finance playbook.
The cons of co-signing
If the pros of co-signing mostly benefit the primary borrower, the cons of co-signing mostly affect you. Since you’re viewed equally in terms of responsibility for the loan, if the borrower defaults on the loan, you can be held accountable for that debt. Especially if you aren’t aware that payments are being missed, you might not find out until the loan is in collections and has already harmed your credit. This means that before you sign on to a loan, you should always think through how taking full responsibility for that debt would impact your life and personal finances.
Since your credit score is connected to whatever loan you’re co-signing, any missed payments or late fees incurred by the primary borrower are also your obligation and can negatively affect your credit score. You’ve probably heard before that lending money can cause major rifts in your relationships with family members or friends. This is particularly true in the case of co-signing, since someone leaving you on the hook for a loan you co-signed for can wreck your personal relationship with that individual as well as your personal finances.
Questions you should ask yourself before you co-sign
If you’re still feeling a bit unsure about whether or not to co-sign on a loan, it can be helpful to think through the negative and positive possibilities that you open yourself up to when you co-sign on a loan. It’s generally recommended not to co-sign on a mortgage—the most expensive loan you’ll likely ever take out—unless you’re married to that person. That being said, for things like student loans or automotive loans, there’s likely going to be a bit more nuance involved in your decision-making process.
Here are just a few questions to ask yourself before you commit to co-signing on a loan:
Do I have a good relationship with this individual?
The first question you’ll want to consider when determining whether or not to co-sign on a loan with someone else is what your relationship is to that person. A parent, grandparent, aunt, or uncle may feel more of an emotional pull to help their child, grandchild, niece, or nephew than someone who’s only a casual acquaintance.
Beyond defining your relationship to better understand what emotional pressures you might be facing, you need to honestly decide whether or not you have a good relationship with that person. Just because someone is related to you doesn’t mean you owe them special treatment. Especially if you’ve seen the person exhibit poor financial habits before, this could be a major warning flag not to move forward with co-signing a loan. Trust is paramount as a co-signer.
Am I financially stable?
Another important consideration is how your own personal finance goals are stacking up prior to taking on another loan. Are your credit cards paid off? Do you have debt from an auto loan, student loans, or your own mortgage that already constrains your monthly budget? Are you contributing to your retirement? Regardless of your credit score, if you’re currently carrying one or two bigger debts, it’s probably not the best idea to co-sign.
How would I feel about taking over this debt?
Even if you trust the person you’re co-signing with, there’s always a possibility that something could change about their life and leave you saddled with that debt. If you know that that’s a possibility, you’re less likely to be blindsided when it occurs and you can better prepare for it. If you’re co-signing on a car lease or car loan, for example, you may be totally fine taking over the payments on the car since you know you could also sell it if push came to shove. When you approach co-signing like a loan you’re taking out yourself, it’s easier to decide whether or not it fits into your financial life.
Why is this person asking me to co-sign with them?
Sometimes, context is another important factor to keep in mind when co-signing a loan. For example, you may be co-signing on your son or daughter’s first car loan with the clear expectation that they are responsible for the monthly payments and you’re only co-signing to provide a safety net for them and get them a better rate. This is a relatively common occurrence depending on your child’s age, and also helps set them up with credit history for the future.
Keeping the “why” behind the ask front-of-mind can ensure that you don’t gloss over the reasons for someone asking for assistance because of a poor credit score. Depending on why their credit score is low, it could be a reason to steer clear of co-signing with that person until they show that they can make on-time payments.
The bottom line
The bottom line
Ultimately, there are a lot of factors to weigh as you determine whether or not you want to co-sign on a loan. While it can feel like a purely emotional decision—especially if it’s a really close friend or loved one asking for your financial help—it’s critical that you think about this decision from a logistical perspective, too.
Remember that if your own personal finances are no longer in check, it could negatively impact your ability to help others in the future financially, too. Just keep the above facts in mind and try and limit any emotional influences and you’re sure to make the right decision.