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Has a friend or relative ever asked you to co-sign on a loan? While it may seem like no big deal at the time and a nice way to help out, there are some serious legal and financial ramifications of this decision. When you co-sign on a loan, you become completely responsible for the payments if the individual defaults. This applies to any type of loan, including car loans, student loans, mortgages and even credit cards.
If you’re having trouble deciding if you should co-sign, keep in mind the impact it may have on you and don’t be afraid to say no if it’s a responsibility you’re not ready for. Let’s take a look at the ways co-signing can hurt your credit score — and your finances.
When you co-sign on a loan, whether it’s a mortgage, student loans or anything else, you are agreeing to be the guarantor of the loan. The person asking you to co-sign most likely needs your help because they either have no credit or bad credit and thus can’t qualify for the loan on their own.
Once you sign your name, you authorize the lender to turn to you if the first signer defaults.
This is why co-signing is so dangerous. If the person who receives the loan fails to pay you are responsible. In many cases this happens five or even ten years down the road, if the loan has still not been paid off. It’ hard to predict what your relationship will be with anyone in a year, let alone ten.
There are actually many ways in which co-signing can hurt your credit score — even if the primary signer holds up their end and makes the payments! Here are just some of the things that may end up happening.
- Debt ratio on your credit report is impacted. When you co-sign for the loan, it will appear on your credit report and impact your debt ratio, which is actually a major component of your credit score. When you go to apply for a loan of your own, this ratio will be used to decide if you qualify and may reduce your ability to borrow money in the future. It can also end up lowering your credit score if you have existing debt in your name.
- Payment history is reported on your credit report. While it’s possible to see an increase in your credit score if the primary signer pays on time, this can also go another way. If they miss a payment or pay late on the loan, it will show up on your credit report, too, and lower your score.
- The loan shows as an open credit account. When you co-sign, the loan will be added as another open credit account on your file. This may be enough on its own to lower your credit score because it will show creditors that you have too many open accounts.
Are you scared yet? Unfortunately, that’s not all that can go wrong. If the primary signer makes a late payment, that can be enough to cause your credit card companies to increase your interest rates!
Technically the lender can also go after you if the primary signer defaults. This means you’re on the hook and forced to take over the monthly payments until the loan is paid in full.
This is the worst part: Some people have even been forced into bankruptcy over a co-signed loan. You can even have your wages garnished or be forced to sell your assets. If you co-sign for a student loan, you can’t even escape with a bankruptcy as these loans typically aren’t dischargeable. You could potentially be forced to pay for that debt for the rest of your life.
Co-signing for a loan can seem like a great way to help someone out, especially if it’s someone you love. Still, it’s important to realize that this has serious ramifications for you as it will almost always affect your credit score in some way. It may even be something that drives you to bankruptcy or a lifetime of debt.
Now with that said, co-signing doesn’t always turn into a nightmare scenario and won’t necessarily destroy your relationship with the person you are co-sining for. However hopefully this makes you think about the situation BEFORE you agree to anything. It may save you a lot of unnecessary headaches and trouble down the road.