One of MSNBC's headline stories yesterday was about a woman who co-signed a home mortgage loan for her friend, who subsequently defaulted. There are several important lessons in this article, not necessarily the ones listed by the author. There are also pages of comments, mostly good, but the take-away from the story is simple: Do Not Co-Sign Loans for people unless you intend to pay the loan if the other borrower does not make the payments.
For some reason, co-signing loans is a common way for people to get into financial trouble. I think that maybe people don't understand what it means to co-sign a loan. I didn't know the first time that I asked my father to co-sign a loan for me. Here are a few facts about co-signing on a loan or credit card of any type:
1. Co-signing carries the exact same level of responsibility as taking out a loan or credit card yourself. From a legal standpoint, you might as well take out your own loan. There is no difference between being a primary borrower and a secondary borrower.
2. Co-signing will instantly increase your overall debt-to-income ratio, which is the total amount of debt that you carry relative to your income. This can have a multitude of results, including making it difficult-to-impossible to obtain your own loan, or having your existing credit decreased because the lenders are concerned about your overall financial situation.
3. Needing a co-signer means that the credit issuer or loan company feels that the original borrower is not a good risk. Trust them - these are professionals who analyze credit risk for a living. They are really good at it. If they think that the borrower is likely to default, why should you doubt their experience?
4. Depending on the lender, a co-signer might not even be notified if the payments are not made according to the terms of the contract. Like the author in the original article, the first time a co-signer learns of the default might be when they try to obtain new credit for themselves. By this time, your credit is already very damaged and the fees and interest have multiplied the original payments due.
5. If you co-sign for tangible property, such as a car or a house, your name isn't automatically on the title or deed. Therefore, you can't even take the house or the car and do something constructive with it. It is totally possible for you to sign for a mortgage, the house to go through a foreclosure, and for you to still owe the balance on the loan. Ditto for car payments - once the car is repossessed, it is repossessed, even if you make the payments.
What should you do when asked to co-sign a loan? First, say NO! No explanations necessary, just no. If you prefer to make it sound nice, perhaps, "I'm sorry, that isn't something I am able to do right now." If you really want to help this person, and you are financially able, you might consider giving them a one-time cash gift. Make it clear that it is a gift, not a loan, and be sure that you think of it that way in your heart. What? You can't afford to give someone money? Then you absolutely can not afford to co-sign their loan.
One thing I have noticed in my financial counseling is that military members are often trying to help their families to the extent that they are sacrificing their own financial stability. In the long term, you won't be able to help others if your own affairs are falling apart. As the airline instruction states, "Put on your own oxygen mask before helping others." As applied to money, it means to make sure that you have done everything (EVERYTHING) that you need to do to take care of yourself and your immediate family before you start assisting others financially. This includes having a sizable emergency fund, being debt free, having contributed significantly to your retirement accounts, having appropriate insurance, etc. Then, and only then, can you afford to make cash gifts to family members.
Please read the original article, and the comments if you have time. And then, file this away: "I'm sorry, I am unable to co-sign on a loan at this time."