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Co-signing Loans Can Come Back to Haunt You

It’s very common for younger people or individuals with little credit, to need a co-signer on their first loan. Usually lenders want to see a borrower with credit history showing they have experience managing a loan and proof of income. If the borrower lacks either of those two requirements, they must find someone to co-sign on the loan.

Many people are unaware of the danger that comes with co-signing on a loan or lease. When relatives and close friends need help with a loan, it can pull at people’s heartstrings. If you’re going to co-sign, it’s so important that you understand the risks so you can protect your own credit and finances.

A co-signer is guaranteeing that if the primary holder cannot make payment on the debts, they’ll be responsible to the remainder of the loan. Any defaults, missed payments, or negative information will go to both the primary and co-signers credit and have a devastating effect on credit and finances.

Example
 Harry was a real estate investor and owned many properties. He had an adult son Jack, age 43, who went through a terrible divorce and now has scarred credit. He asked Harry to co-sign an auto loan since he could not get approval on his own. Harry did not see a problem with this and wanted to help his son improve his quality of life and move on from the tough times he went through. His son was very responsible and always paid his bills on time leading up to the divorce. A couple of years later, Harry saw interest rates drop to all-time lows and wanted to refinance four of his properties. He would have saved 2% in interest on $3,000,000 of mortgages. In total the savings would be $1,244,349 over the life of these loans if he was approved. When the banker pulled Harry’s credit his scores were at a 640. To Harry’s shock there were 10 late payments on the auto loan he co-signed for. Jack eventually told his father that business had been bad and with all the alimony, child support, and student loans he had to pay he was late on numerous occasions with the payments. He was embarrassed and did not want to tell his Dad he was having financial difficulty. Like many others, Jack had no idea his delinquencies would be posted on the co-signers’ credit as well. Sadly, the damage was done and Harry paid a very high price for trying to help a relative. Harry would have been better off paying cash for the car or putting the loan in his name and making the payments monthly himself for his son.

Co-signing is a dangerous process since the co-signers’ credit reports and scores will reflect the payment history made by the primary. This is why you should only co-sign for accounts that you’re responsible for. If his son lost his job and could not pay for the automobile the repossession would be posted on Harry’s credit and he would be financially responsible to the lender for whatever balance was owed. Besides the credit damage there is also the financial burden of having more of a debt load. Since banks look at income to debt ratios and co-signing is a full legal commitment it will be added to the income-to-debt ratio. This could impact future loan approvals or the amount of loan money extended. In addition, failed co-signed loans can cause a lot of resentment and ruin relationships between people.

Please feel free to share this valuable information with any clients who may be unaware.

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