Cosigning Loans--Putting Your Credit on the Line

If a friend or family member asks you to cosign a loan, think twice. And then think again.

Some people who cosign loans don't take it seriously enough because they don't understand all their obligations.

Cosigning Means Responsibility
Cosigners lend their names and good credit histories to the primary borrower (called the maker). If that person dies, loses a job or otherwise fails to make payments, the cosigner is legally responsible to do so.

An often-overlooked aspect of cosigning a loan is the fact that the loan appears on both the maker's and cosigner's credit reports. If the maker doesn't pay, you will be notified. If you do not pay, the delinquency will be reported on your credit report.

It's Your Debt, Too
Even if it is not delinquent, a cosigned loan is part of your credit history. That could cause problems if you wish to obtain a new loan for yourself. Since financial institutions consider a cosigned 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.

To calculate the ratio, the lender adds up all your monthly payments--credit card bills, mortgages, student loans, car loans, etc.--and divides the total by your monthly income. (Some lenders use gross income, others use net income.) The total amount of unused credit available to you is also considered in the equation.

The cut-off point varies widely among financial institutions and the type of loan. But if it's too high, the result is the same: your loan application will be denied--even when your family or family member never misses a payment on the cosigned loan.

So Why Do It?
Considering the risks, you may wonder why anyone would consider cosigning a loan. The answer hinges on how badly an individual wants the borrower to get credit and how much risk he or she is willing to take.

Often, parents cosign for their children who have adequate income but a lack of credit or employment history.

By cosigning, parents help their offspring get the loan and, more importantly, establish credit in their own names.

To Cosign or Not to Cosign
Before making a decision whether to cosign a loan, consider the following:

• Federal regulations do not require you to be related to the primary borrower to cosign a loan, but individual financial institutions may have stricter policies.
  
  
• Cosigners differ from joint applicants. When granting a cosigned loan, financial institutions qualify both persons individually. In other words, each must have adequate income to repay the loan. With joint loans, the incomes (and debts) of both people are combined, and the couple qualifies together. Most, but not all, joint loans are granted to married couples.
  
  
• As a cosigner, you should know the purpose of the loan, the type of loan, the terms, and why your friend or relative needs a cosigner.
  
  
• Understand your legal and financial obligations. Federal law requires financial institutions to tell you in writing that you are responsible for paying the debt if the borrower can't or won't make loan payments.
  
  
• Read and understand the credit contract. Be aware that a lender may be able to collect from you even when there is security for the loan. In the case of a car loan, for example, 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.
  
  
• In the case of a default, the credit grantor can demand payment from you without trying to collect first from your friend or relative.
  
  
• If your friend or relative defaults on the loan, you may have to pay late fees or collections costs in addition to the loan amount.
  
  
• If in doubt, don't cosign a loan.