Consider the Risks Before Co-Signing Loan for Relatives or Friends

Have a heart, but use your head--and watch your wallet!

That’s the not-so-simple advice you must try to follow whenever a friend or relative asks you the large favor of co-signing for a loan.

It is one of those delicate moments in life when your common sense, and your emotional sensibilities, may pull you hard in opposite directions at the same time.

How you answer comes down to a personal decision. But on one point the experts agree: No matter what your reasons for doing so, you should enter into such a deal with your eyes wide open.

“Co-signing a loan puts your credit on the line,” points out TRW Information Systems & Services, the credit reporting firm, in a current consumer-finance bulletin. “Some people who co-sign loans don’t take it seriously enough because they don’t understand all their obligations.”

The idea of co-signing is simple: to help someone you care about and trust get access to credit that lenders won’t extend on the strength of the borrower’s qualifications alone.

When you co-sign the loan contract, you promise to pay off the debt if the borrower fails to make good on it.

“Don’t co-sign any loan unless you know the borrower well, have good reason to believe he or she will repay it, and are prepared to repay the loan yourself if necessary,” says Grace Weinstein in her Lifetime Book of Money Management.

If you determine that you are willing to co-sign, experts add, check the whole deal over thoroughly before you put your name on the line.

That way, you will be aware in advance, for example, that you may be dunned even if the primary borrower misses just one payment, and even if there is collateral, such as a car or boat, pledged on the loan.

“In the case of a car loan, for example,” says TRW, “the lender might demand payment from you instead of repossessing the car. And even if the car is repossessed, its value may not be sufficient to pay off the loan.”

Before you sign, furthermore, you want to make certain that the contract doesn’t use any of your assets, such as your own car or house, as security for the loan.

After hitting you for payments that haven’t been made, the lender may also dip into your pocketbook for late fees, collection costs and extra interest charges.

Also, TRW says, co-signers need to bear in mind that the promise they make can affect their own credit standing, regardless of whether the primary borrower ever misses a payment.

“Even if it is not delinquent, a co-signed loan is part of your credit history,” TRW notes. “That could cause problems if you wish to obtain a new loan for yourself.

“Since financial institutions consider a co-signed loan your responsibility, they’ll include it when calculating your debt-to-income ratio. This ratio is an important factor that financial institutions consider when deciding whether to grant a loan.”

Despite all these problems and pitfalls, the case for co-signing may look compelling if, say, you want to help a child qualify for credit for the first time, or support a valued friend recovering from a layoff or other financial setback.

Even in such cases, however, you might check alternative ways to accomplish the same mission, such as a gift of assets that helps the borrower obtain secured credit on his or her own.

What to do in borderline cases where the decision seems too tough to make?

Says TRW: “If in doubt, don’t co-sign a loan.”