Co-signing a Loan? Here’s what you Need to Know

A family member or friend asks a you to co-sign a loan or mortgage. Should you do it? There are a few things you should consider first, and some important questions to ask prior to signing on the dotted line. If you’re not informed before you co-sign a loan or mortgage, you could put your own finances at risk.

Why is the Bank asking for a Co-signer?

Parents and other family members often co-sign loans to help out their children/grandchildren/siblings. Anyone can co-sign a loan for anyone else if their financial position is strong enough.  The big questions are: Why is the bank asking for a co-signer? and How will this impact my financial position?

The answer to the first question is this:  the bank has reviewed the risk and determined that they are not willing to lend the applicant money based on the assessment of the loan application. The assessment is based on the applicant’s Financial Health. 

So if the bank isn’t willing to take the risk, should you?

When you agree to co-sign you are essentially saying that you are willing to make the payments on the loan and pay the balance in full if required.  If you are not willing to do that – don’t co-sign!

The Impact to your Financial Position 

Co-signing a loan will impact your debt servicing. Debt Servicing is an assessment of whether you have enough income to make your loan payments. When you co-sign a loan, the payment is considered as your payment.  Why does that matter?  Because if you are trying to borrow money in the future you may not qualify for a loan if your debt servicing is too high.  It doesn’t matter if the primary borrower is making the payments on the loan. The co-signed payment will be added to your total payments when calculating debt servicing. 

So before you co-sign, calculate how this will impact your debt servicing, especially if you are planning on borrowing money before the co-signed loan is paid in full. There’s an example of a debt service calculation in my Financial Health post.

Your Credit Score

Co-signing a loan might negatively impact your credit score.

Here’s a story I’ve heard many times:

I helped my boyfriend/girlfriend out by co-signing their car loan.  Now they’re not making the payments and they have the car.  The collection agency is calling me, What can I do?  It’s not my loan!

Let’s face it; your boyfriend/girlfriend is probably saying the exact same thing to the collection agency- that you have the car and they were just helping you out.  The point is, it doesn’t matter who’s helping whom or who has the car. Both of your credit ratings are being damaged. And if the payments don’t get made, eventually the bank will repossess the car, sell it, and write off the balance of the loan.  You will have that on your credit record for the next 7 years. Good luck borrowing money for a while!

The truth is that you will not even know that loan payments aren’t being made right away. By the time you are contacted about the loan arrears there can be 2-3 payments missed. By this time you will already have a “minor” blemish on your credit bureau.  If this happens 3 times over the course of the loan it’s now a serious detractor to your credit score.

When to Consider Co-signing a Loan

There are times when you may feel it is necessary to help someone in the family establish credit. Co-signors are almost always required for a Student Line of Credit.  The reason for this is because young people either have a lack of credit history, limited net worth, or both. The bank will want some extra assurance if they are going to lend $45,000 without any collateral.

Assisting your child by co-signing helps them build their credit rating. The loan is for a good purpose and the reasons for requiring a co-signer are simply because they are too young to have established their finances. Even so, I will repeat what I said earlier because it is the most important part of the decision to co-sign.

Are you willing to make payments on the loan and prepared to payoff the full balance if the applicant does not?

There are other times when it might make sense to co-sign. Most people will pay back their loans and make their payments on time. If you are asked to co-sign, the important thing you need to know is why the loan was declined.  Whoever is asking you to co-sign should agree to divulge their full financial picture to you.

Some Reasons not to Co-sign a Loan

In my post about Financial Health, I outlined 3 main factors that are considered when the bank is deciding to lend someone money. Since you are essentially agreeing to lend money then you need to consider these factors as well.

Credit History

When someone asks you to co-sign because they have poor credit, think twice.  Poor credit means they don’t make their payments so there is a good chance you will be. Stuff happens in people’s lives. They get ill, run into problems with a business partner, get scammed out of money. However, they have good intentions and eventually have the ability and desire to get back on track.  As a co-signer you have a right to know the details of their credit history. Find out if a low credit score is due to lack of credit, minor credit problems from a long time ago and now back on track, or if its recent and lots of bad repayment.  If it’s the latter – I wouldn’t recommend signing.

Debt Servicing

This is the ability to make payments from your current source of income.  If someone is just starting out they aren’t on the job long enough for the bank to verify income so they may need some help.  This is different than if someone clearly can’t afford the payment. If it’s determined by the bank that someone can’t afford the payment, then it’s likely they’re going to be unable to pay.  Probably not a good idea to co-sign.

I wouldn’t recommend co-signing any revolving credit such as a personal line of credit or home owner line of credit.  These products provide ongoing access to credit with only minimum payments required. If you co-sign a regular loan or student line of credit, the money needs to be paid back over a specified period of time. Whereas, with a line of credit, a person can keep re-borrowing so you’ll be on the hook for as long as they have that product.  

Mortgages

Mortgages are a long term debt so consider that you could be on the hook for payments for the next 25 years.  A lot can happen over that length of time.  And mortgage payments are quite high so think about the impact to your debt servicing when you sign for a mortgage.  I know people think they will just get their names removed from the mortgage later on but it’s not that simple.  The borrowers will need to apply and be approved in their own names and then the title to the property will need to be changed.  The cost to changing a title and refinancing a mortgage is roughly $2000 (title costs are based on the amount of the mortgage).  So it’s not cheap to do this!

If You Decide to Co-sign

Ready to co-sign? Here’s what you want to find out.

  • Understand clearly why you are being asked
  • Get a full picture of the borrower’s financial position and credit history 
  • Monitor the loan repayment monthly 
  • If there are any late payments, make them and collect from the borrower. You have 30 days from the due date of the payment before it reports on a credit bureau.
  • Ask the borrower to take loan insurance that covers life, disability, and job loss. This protects you if anything unforeseen happens to the borrower.

Do you have questions or thoughts on co-signing? Please comment or contact!

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