The following is a guest post about the decision to co-sign a loan. If interested in submitting a guest post, please read my guest posting policy and then contact me.
Has a friend or relative ever asked you to co-sign a loan for them? Maybe they needed the loan to buy a car, to go to college, or even to pay off other bills.
Did you help them out?
Was it worth it?
Let’s take a look at a hypothetical situation that demonstrates how the typical loan with a co-signer works and see if it’s worth it.
Cousin Eddie Needs a Co-signer
Let’s say your cousin Eddie goes to the bank to get a loan for a car. Eddie has been down on his luck for awhile. He lost his job, was late on some bills and has been struggling.
The bank tells him that he doesn’t qualify for the loan because his employment has been spotty lately and he doesn’t have a good credit score due to paying some of his bills late.
However, they tell him that there are possible options that can make him qualify for a loan. If he can find a qualified co-signer, then he can have the loan.
That’s where you come in.
Eddie tells you about his dilemma, and being the kind hearted person you are, you decide to co-sign on the loan to help the guy out.
What Could Go Wrong?
Eddie swears he can pay back the loan, and even plans on paying it back early using the income from the new job he just got. You trust Eddie because you know he’s a pretty good guy, and besides, he’s family. You’re supposed to help your family, right?
6 months or a year go by and Eddie is driving his new car to work every day. Everything seems to be going well and he seems to be getting back on his feet.
Then you find out Eddie’s company decided to downsize and let Eddie go… 3 months ago. He was too embarrassed to say anything about it.
Then you get a letter in the mail that the car payment hasn’t been paid in a couple of months. You need to send the money now or the car will be repossessed.
Now Eddie’s problem has become your problem. You are on the hook for the back payments and late fees as well as the rest of the payments going forward.
Your kind hearted gesture has officially blown up in your face.
Where Did You Go Wrong?
Yes, this is a hypothetical story, but it’s pretty typical of what happens when one person co-signs on a loan for someone else.
Why is this a typical story? It’s because the borrower that needed a co-signer cannot afford the loan.
The bank, which is in the business of loaning money, decided that cousin Eddie was a bad risk.
But you knew better…
Maybe you did it out of guilt.
Maybe it was to help a guy who was down on his luck.
Maybe it was some other reason.
Whatever it was, when you signed those papers you were saying you knew better than the lending professionals. You were also saying that you were willing to take the risk and pay for a car that wasn’t yours if cousin Eddie couldn’t pay.
But were you really ready to take that risk?
What Happens Next?
Now you’re stuck with a car payment and Eddie’s driving a free car thanks to you. Eddie swears he’ll make it up to you, but it’s kind of hard when he doesn’t have a job.
You and Eddie don’t talk much anymore.
You keep hoping that one day he’ll show up with a check to make it right, but it never happens.
What Are the Consequences?
Once all of this went down, you suddenly started realizing a few things that you didn’t think about when you signed your John Hancock to those loan papers.
- Your Credit Score Got Smashed – When cousin Eddie stopped paying the loan, it had the effect of hurting your credit score because your name is on the loan as well.
- You Now Have One Less Cousin – The relationship with Eddie is just not the same. You can’t talk to the guy without thinking about how you got screwed in the deal. And he’s still driving the car.
- You Didn’t Think Enough About the Risk – Even the best intentions can get you into trouble when you don’t think about just how badly this deal could go. Always assume the worst will happen, because when it comes to co-signing, it usually does.
How Do You Avoid Problems Related to Co-signing a Loan?
The best way to avoid these problems is to NEVER co-sign on a loan for any reason. They can’t afford it, and you can’t afford to deal with all the problems that usually come with it.
If you really want to help someone out without putting yourself at risk, tell cousin Eddie that you don’t co-sign loans for anyone.
Then, if you still want to help, you can:
- Offer to Give Them Some Money – You can help as much as you want without putting yourself at greater financial risk.
- Offer to Help Find an Alternative – There are always creative ways for someone to get what they need without going into debt and dragging other people into the situation.
Co-signing a loan can be one of the worst moves you can make financially. It can be so easy to let the best of intentions get you into the worst of trouble.
But when you act wisely and realize just what kind of trouble co-signing on a loan can cause, then you’ll be one step ahead of the game.
Have you ever co-signed on a loan for someone?
What kind of experience did you have?
Leave a comment and tell me about it.
Author Bio: Dr. Jason Cabler is a Christian personal finance blogger, author, and speaker. He teaches how to get out of debt and live a debt free lifestyle through his Celebrating Financial Freedom blog and self study course. His new book “How to Budget- The Quick and Easy Guide to Making a Budget That Works” is now available on Amazon. He can be reached for interviews or speaking engagements by email, and can be found on Twitter (@DrCabler), Facebook, and Google+.