When you co-sign a loan for someone else, you take on full responsibility for the debt if they default. Co-signers end up paying the loan 75% of the time when the primary borrower defaults. Co-signing is especially risky for student loans, as many graduates struggle financially and default rates are rising. While it's difficult, the best way to help someone is not by co-signing but by offering a cash gift instead to avoid potential damage to your own finances and credit over many years.

1. Co-Sign a Loan: Bad Idea
Submitted by Larry Frank Sr. on Mon, 03/04/2013 - 12:00pm
If you have a family member or a friend who has bad credit, co-signing a
loan agreement is not the best way to help. You take a lot of risk when
you co-sign, and get none of the loan’s benefits.
In today’s economy, it isn’t uncommon for someone to need a co-signer to
qualify for a desperately needed loan. Very often, parents co-sign for
student loans to secure more favorable interest rates for their kids.
Also, to qualify for a credit card today, you need to be over 21 years old
and have adequate income. Not all young people have that, and their
parents must co-sign if they need access to credit for a car, home, living
expenses or education.
What folks often don’t understand is that when you co-sign a loan for
someone else, you are taking on exactly as much debt as the main
borrower.
That’s right. Even if you are completely debt-free, you are technically a
debtor if your name is on someone else’s loan. Your credit rating goes
down because the co-signed loan is your debt in the eyes of the credit
bureaus. This reduces your own ability to borrow because of your higher
credit utilization rate. As long as that co-signed loan is unpaid, your own
credit is held hostage, too. You might be denied for credit, or forced to pay
higher interest rates.
This means that even if the borrower acts in good faith and pays back the
loan quickly, you ultimately lose money. And that’s a big if.
The reality is that co-signers end up paying more often than most people
expect. According to the Federal Trade Commission, for co-signed loans
go into default, the co-signer pays 75% of the time. As the FTC points out,
“When you’re asked to co-sign, you’re being asked to take a risk that a
professional lender won’t take.” Your short-term help may turn into a

2. lifetime of hurt feelings if the real borrower doesn’t repay and you end up
with the bill. It is usually better to refuse to co-sign.
Since co-signing is common for student loans, it is especially pernicious.
So many graduates are unemployed or underemployed, and the default
rate for university debt is rising. The Department of Education reported
that the three-year default rate for the 2009 graduation cohort was to
13.9%. The rate is even higher for private institutions. Government-
issued student debt can’t be discharged in bankruptcy.
As a co-signer, you have no borrower rights. The lender won’t talk to you
directly about the loan until you become the borrower when the original
borrower defaults. You aren’t notified that the loan is in danger until it is
too late. You don’t have the option of refinancing, consolidating or
reducing payments, either.
Given these risks, you should politely refuse to co-sign. Of course,
nobody wants to be seen as miserly with his own family. But there are
other ways to help. Instead, offer a cash gift to help them out. At least the
limits of your ability to help them are explicit in that case, rather than a
potential lifetime of payments.
It’s hard to say no to a family member in need, but those feelings soon
fade. Anger about repaying a loan (plus interest) for someone else and
seeing your own credit ability harmed, doesn’t go away quickly.
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Larry R Frank Sr., CFP, is a Registered Investment Adviser (California)
in Roseville, Calif. He is the author of the book, Wealth Odyssey. He has
an MBA with a finance concentration and B.S. cum laude in physics with
which he views the world of money dynamically. He has peer-reviewed
research published in the Journal of Financial
Planning. www.blog.BetterFinancialEducation.com.
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Topic:
College Funding
Personal Spending
Debt Problems