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When a loved one asks you to cosign a loan

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July 28th, 2017
Cosigning a loan.

Cosigning a loan.

Should you ever cosign on a loan for a family member or friend? The short answer, of course, is no. But life isn’t always black and white.

“It’s never a good idea to cosign for a loan or credit card,” says professional trader and investor Vic Patel, founder of Forex Training Group (forextraininggroup.com). “With that said, if you have excellent credit and have demonstrated to people around you that you are financially responsible, chances are you will, at one time or another, be approached by a relative or a friend for help in obtaining credit.”

When the inevitable happens, it’s important to have all the facts. First, Patel says that more than two-thirds of people who cosign a loan end up making the payments on the loan. That means you definitely shouldn’t cosign unless you have enough cash set aside to cover the entire debt.

Jeremy Smith, a compliance officer with PolicyWorks (policyworks.dynamicwebware.com), which helps credit unions manage regulations, says you should also consider the circumstances that led your friend or relative to ask for help. Do they have a mark on their credit that’s preventing them from getting a loan? Or do they not have enough income to pay back the loan? Smith says the latter tends to be more dangerous for cosigners. 

“For a situation where the friend or relative can’t afford to make the payments, the cosigner is the first person on the hook to make the remaining payments,” he says. “Often the cosigner is also not taking title to whatever is securing the loan, so at that point they also don’t have rights to the collateral securing the loan. So that leaves them stuck with the bill and nothing to show for it.”

Ways to minimize risk

If you do decide to put yourself on the line to help a loved one, there are some ways to minimize your risk. Smith advises you list yourself as the co-owner of any collateral that secures the loan. Or you could offer to be a guarantor rather than a cosigner. 

“The key difference between the two is that in the case of a guarantor the lender has to exhaust every option of settling with the borrower before collecting from the guarantor,” Smith says. “That is not the same for a cosigner.”

Carmen Dellutri (dellutrilawgroup.com), a lawyer who specializes in debt and bankruptcy, recommends putting the total amount of the loan into a separate account, where it can earn interest and be available in the case of a default. And she says to require proof of payment two weeks before payments are due, so you have time to plan in case you must foot the bill.

Of course, you may decide that cosigning is not right for you. That can put a strain on your relationship with the person who asked for help, but there are ways to soften the blow. Smith says to explain why it’s risky for you to cosign and tell them that you simply don’t have the resources to cover the debt if unforeseen circumstances prevented them from paying. And Tennessee financial adviser Rosemary Frank (RosemaryFrank.com) says another option is to simply give them cash.

“If you want to help someone and can afford it, then give them a gift and keep them and their actions out of your business and off your credit report,” Frank says. “If you cannot afford a gift, then you cannot afford to cosign.”

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