If you have been asked to co-sign a loan for a friend or family member, you should familiarize yourself with all that the process involves before you make your decision.
The co-signer agrees to share the responsibility of the loan, and in the instance that the borrower is unable to pay, the co-signer will have to. Don’t dismiss this possibility; the Federal Trade Commission (FTC) cautions that “studies of certain types of lenders show that for co-signed loans that go into default, as many as three out of four co-signers are asked to repay the loan.”
Before co-signing, be sure that you would be financially able to pay the full amount if called upon in the future. Do you anticipate your financial situation changing due to events like moving or starting a business? If so, you may be able to afford to pay off the loan now but become unable to in the future. Furthermore, it is possible that you may have to pay even more than the full amount of the loan if the borrower incurs late fees or other collection costs. While meeting with the creditor, ask if they would be willing to calculate the total amount that you could owe on the loan, so that you are fully informed. It may also be possible to negotiate the contract so that you are responsible only for the original loan sum, not for fees in excess of that amount.
Asking yourself why the borrower needs a co-signer can help you make your decision. If that person’s inability to receive a sufficient loan independently is due to the fact that he or she has defaulted on a loan in the past, you should discuss why this time will be different. On the other hand, if the borrower needs a co-signer because he or she hasn’t established enough credit due to age or the fact that he or she is just beginning to gain equity, then you may feel more confident that the loan will be repaid. In making your decision, imagine that you are a bank and try to determine why the person needs a co-signer and if that reason suggests that he or she will likely default.
Make sure that you know all the stipulations of the contract. If you are submitting your personal property for collateral, be sure to fully consider what would happen if those items were possessed. The Federal Trade Commission suggests that you “ask the lender to agree, in writing, to notify you if the borrower misses a payment. That will give you time to deal with the problem or make back payments without having to repay the entire amount immediately.”
It is also important to consider how the co-signing process will impact your finances. The amount of the co-signed loan will be taken into account by banks should you decide to take out a loan of your own. This may make it more difficult for you to receive your own loan, so think carefully about whether or not you may need to borrow money in the future. Furthermore, if the borrower defaults and you are unable to pay, it could negatively affect your credit score.
Finally, make sure that you are in possession of all copies of relevant paperwork in order to protect yourself in the event of a disagreement between the borrower and lender. These can include warranties, truth in lending disclosure statements and the loan contract. The FTC cautions that the lender is under no obligation to provide you with this paperwork, so make sure that you communicate to the borrower your wish to have copies of these documents.