Why You Don't Want to Cosign a Loan
So far this chapter has focused on loans you don't want to get. But there are loans you should avoid giving as well.
You may not think you're lending anything when you cosign a loan for someone else. But while you're not putting up any cash, you are lending your good name—and that may come back to haunt you. Read what happened to Doug in Ohio:
“I was the cosigner on a vehicle for my sister-in-law. I got the whole 'You're the only one who can help me,' 'If I don't have a car, I can't get to work, then I can't pay my bills...' and so on. Being soft-hearted, I gave in and cosigned for her. To make a long story short, she defaulted on the payments, had the vehicle voluntarily repossessed, and is currently filing bankruptcy on the balance, which is about $18,000. I by no means have the resources to pay for the defaulted portion, so I am in the process [of filing for bankruptcy too]. I already have two vehicles, a rent payment, insurance, a wife who is not working, and a four-year-old daughter. My credit rating before this incident was flawless, and I scored around 850. Now, from my most recent report, about a year ago, it's at 650. I am so bummed out.”
Many people who cosign a loan are surprised to learn that legally they're just as responsible for making the payments as the other borrower. Late payments or defaults wind up on both parties' credit reports, and either party can be sued for repayment.
If someone asks you to cosign a loan, she probably has either bad credit or no credit. This means that, even in today's easy-lending environment, either no lender is willing to take a chance on this person, or the lenders that are want to charge sky-high interest rates to reflect this borrower's risk of default. If lenders have such a poor opinion of this borrower, you should think hard about whether you want to put your good credit rating in her hands.
Table 9.1 shows the chances that a borrower will default based on her credit score. The chance that someone with a FICO score of 800 or above won't pay her bill is just 1%, while someone in the 600 to 649 range is expected to default almost one-third of the time. Below 500, the chances of default rise to 83%.
| FICO Score | Default Risk |
|---|---|
| 800+ | 1% |
| 750–799 | 2% |
| 700–749 | 5% |
| 650–699 | 15% |
| 600–649 | 31% |
| 550–599 | 52% |
| 500–549 | 72% |
| Up to 499 | 83% |
| Source: Fair Isaac | |
You may still decide to go ahead. Cosigning a loan can be a way to help a trusted young person build her credit history, or you may be helping someone who's trying to recover after a credit disaster. Whatever your reason, take the following precautions:
Don't sign if you can't afford to pay off the loan yourself. Picture the worst-case scenario: Your coborrower on a car loan skips town, for example, leaving you with the debt but no vehicle to sell to help pay off the loan. If you couldn't make the payments, don't cosign the loan.
Don't sign if you don't have control over the payments. The lender isn't required to notify you if your coborrower falls behind, so by the time you know there's trouble, your credit's probably already been trashed. Make sure that the loan statements and payment coupons are sent to you so that you can monitor the loan. Your coborrower can send the checks to you, and you can forward them to the lender. A hassle? Yes, but it's a small price to pay to protect your credit.