Cosigning a loan for a friend or family member can be a feel-good experience. On the other hand, adding your name to someone else’s financial obligation is a huge responsibility that can be devastating to your credit. So, is cosigning a loan the right thing to do? Only you can make that determination.
Whether it’s for a vehicle loan, mortgage, student loan or apartment lease, adding your signature to someone else’s promise to pay is nothing short of your commitment to take responsibility for that borrower’s debt if that borrower fails to live up to his or her obligation. The commitment is serious business and can affect many aspects of your financial future. Here’s why.
First, there are many reasons why a borrower might need a cosigner. Perhaps your child has no credit history and needs a “boost” to get their financial life underway. In that case, the benefits of cosigning may outweigh the financial risks associated with putting your good credit on the line. Alternatively, a person may need a cosigner because they don’t have sufficient credit to qualify on their own. Will adding your commitment to stand behind them financially change their bill-paying habits? In many cases, the answer is no.
In general, the risks of cosigning a loan outweigh the benefits. For example, adding someone else’s debt to your existing obligations can easily impact your debt-to-income ratio (DTI). DTI s the ratio of your debt payments to your income. A person who earns $4,000 per month and has debt payments of $1,500 per month has a 37.5 percent DTI. Cosigning for someone who is taking on a $500 per month payment for a vehicle or home loan or lease increases the cosigner’s DTI to 50 percent, which could easily prevent the cosigner from qualifying for a vehicle or home loan of their own.
Another downside to cosigning is the possible reduction of the cosigner’s credit score. Since lenders don’t notify a cosigner when the primary borrower makes a late payment, misses a payment or stops paying altogether, many months could pass before the cosigner realizes that the primary borrower’s indiscretions have negatively impacted their credit score. That’s because 35 percent of a person’s score is based on whether that person makes their payments on time.
Cosigning can also tie up a cosigner’s credit for an extended period of time. Once a cosigner signs on the dotted line, they’re typically obligated to remain on the loan until the loan is paid off or refinanced into the primary borrower’s name. The obligation to pay could be as short as 3 to 6 years for something as simple as a vehicle loan, or as long as decades for something as daunting as a 30-year mortgage. And should the primary borrower become incapacitated or pass away, responsibility for repayment falls squarely on the shoulders of the cosigner.
Cosigning is not the only method of helping a friend or relative establish or improve their credit. Adding the person as an additional cardholder on one or more of your credit card accounts is an easy and safe way to establish or add positive lines of credit to someone else’s credit files, without affecting your credit. The key is to maintain control of the card usage by denying the other person access or placing strict controls on the card. The other person can also establish their own line of credit through the use of a secured credit card, which limits the credit usage to the amount of money the person deposits into the secured card’s account.
That excellent credit score you’ve spent years building can be negatively affected if the person on whose behalf you are cosigning fails to hold up their end of the bargain, so think carefully before grabbing that pen.
See you at closing!
Gary Sandler is a full-time Realtor and president of Gary Sandler Inc., Realtors in Las Cruces. He loves to answer questions and can be reached at 575-642-2292 or Gary@GarySandler.com.
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