It is a very natural thing to want to help out a family member, or close friend, by helping them to secure a loan. The easiest way to help someone get a loan is to be a co-signer for them. However, choosing to be a co-signer is not always the wisest choice. Let’s take a quick look at how co-signing on a loan will affect your credit rating.

James* (name changed) had recently gotten a divorce. His ex-wife had done her best to ruin his credit just before, and just after his divorce. Once they separated, she kept the house, and James no longer had a place to live.

Since his wife had recently charged up several of his credit cards, he was carrying high balances. They had also been through several rocky periods during their marriage when money was tight and they did not always pay their bills on time.

After the divorce, James temporarily moved back in with his parents. He had no desire to stay there for long however, and he soon began looking for a house of his own.

James located a small home that he thought was perfect. He and his ex-wife didn’t have any children, and it was just the right size for him to start his new life.

When James went to apply for the home loan, he was turned down. Because of his spotty payment history, and currently high credit card balances, the bank felt like he was not a good credit risk, and suggested that he get a co-signer for the loan.

Not knowing anyone else to ask, James asked his father.

Dan, (James’ father) had excellent credit. He and his wife had practiced good credit habits throughout their lives, and believed they taught James to do the same. After some deliberation, Dan did decide to co-sign for James so that he could move on with his new life.

With Dan’s help, James got his home loan, moved out of their house, and into his new home. All went well for about six months until James was laid off. His company “downsized” him, with a small severance package.

After that though, James wasn’t immediately able to find another job that paid as well as the one he lost, and the money from his severance package quickly ran out. He started missing payments on his credit cards, and eventually was late paying his mortgage.

The day he got the late notice for his mortgage, his Dad called him. As it turns out, Dan had gotten a late notice too. He offered to help James make the payment that month, and James gratefully accepted.

The next month, Dan got another late notice in the mail, and he called James again. James told him that he just didn’t have the money right now, and he was still looking for a job. Dan finally had to tell him, “Son, I can’t make your mortgage payment and mine too, I’m sorry.”

Everything went downhill from there. James did take another job, but it did not pay as well as his old one, and every month he was forced to pay a few bills late to avoid having his car repossessed or his credit cards shut off. With every late payment there were penalties tacked on, fees added, and things got worse for James. Eventually he missed two mortgage payments in a row.

At this point, Dan called James. The bank had been calling Dan at home, asking him to make a payment instead of James. When Dan told them it was his son’s house, not his, the lender replied “Your name is on the loan, and this debt is your responsibility.”

After that phone call, Dan checked his credit report. What he found was not pretty. Every time James missed a payment, it showed up on Dan’s credit report. In effect, James’ mortgage showed up on Dan’s credit report just as if it had been his own mortgage, and his own late payments.

Co-signing for James literally destroyed a lifetime of good credit habits for Dan and his wife.

So, what should you do if someone asks you to co-sign for them?

Make an informed decision.

Remember that no matter who it is you want to help, you are tying your financial future to theirs when you choose to co-sign for a loan. Since it will show up on your credit report just as if you had borrowed the money yourself, and you will owe the full amount of the debt if they default – take it seriously.

Before you co-sign, ask yourself these questions:

• Can I afford to make this payment if they default?
• Do I think there is any chance at all that they will default on this loan?
• How will the new loan affect my credit score?
• Is there anything that I am going to want to borrow money for in the near future? How will this loan affect that?

As long as you remember that you will ultimately be the one who is responsible for the loan in the event of a default, then you can make an informed decision. Co-signing is not for everyone. If it is not something that you are comfortable doing, don’t let your family or friends guilt you into it anyway.

Co-signers can be sued in court, just like the person who took out the loan in the first place. In fact, if you co-sign for someone, and they are late on their payment, lenders have the right to call you to collect the money before they call them! You can have your wages garnished, your property seized, and be harassed day and night for payments if things go badly.

Also, there is one more thing to consider. Co-signing for a friend or family member may help them right this second, but it will not help get their credit back on track as much as you think. Statistically, when people have poor credit, and banks see a co-signer for a loan, they are more likely to ask that person to get a co-signer again. So, by helping them out now, you could actually be making future loans more difficult for them, and you.

Whatever you decide, do not feel badly. Just be informed. If you go into a co-signing situation aware of the risks and prepared for them, then it’s possible it could be a winning situation. If you are unprepared, you run the risk of losing your own good credit history and owing the money that the other person borrowed.

Have a question for us? Leave a comment below!

Keep Reading:

• Credit Card Debt Settlement – How To Do It Yourself
• Repairing Your Credit After Bankruptcy Part 1
• What is the Best Way To Pay Off A Large Chunk of Debt?

This entry was posted on Thursday, October 16th, 2008 at 09:45 and is filed under Reader's FAQ. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.