Think Twice Before Cosigning a Loan
I understand the benefits of cosigning a loan for someone. If you’re just starting out and don’t have a credit history, getting a student loan, auto loan or credit card might require a cosigner. As a matter of fact, if it weren’t for my dad cosigning my first auto loan, it would had taken me longer to purchase a car.
But although cosigning is a common financial practice, it’s risky territory. A couple weeks ago I read an article about a grieving couple who had to pay their deceased daughter’s private student loan debt. The original debt was for $100,000, but after late penalties and interest fees, the loan balance increased to $200,000 — a huge blow to this couple’s personal finances.
I sympathize with their situation. Not only are they dealing with the death of their daughter (and raising her three young children), they’re now responsible for a large debt that isn’t going away anytime soon. Private student loan debt cannot be discharged in bankruptcy, and since her parents cosigned the student loan, they inherited the debt after her death.
For any cosigner, this is probably one of the worst situations to be in. There’s always the risk that the person won’t pay. However, it’s easier not to assume the worst — and to be fair, many primary signers are responsible and don’t damage their cosigner’s credit. But as in the case of this daughter and her parents, there are times when cosigning can go incredibly wrong.
The harsh reality is that banks want their money regardless of the situation — even when it’s tragic. You can call the bank, explain the situation and pray for forgiveness, but banks aren’t obligated to write off or forgive debt. Cosigners are just as responsible for a debt as primary signers. And from a bank’s standpoint, if a primary signer can’t cough up the cash for whatever reason, it’s a cosigner’s duty to step in and take over payments.
Personally, I won’t gamble with my credit score, but to each his own. At the end of the day, you have to decide whether cosigning a loan or credit card is worth the risk. This isn’t a decision to take lightly, especially when cosigning increases your debt-to-income ratio. If you’re planning on buying a house or car in the near future, too much debt can affect whether you’re approved for financing.
As a rule of thumb, you should only cosign if you can afford the loan payment, and still keep up with your regular monthly expenses. And since you may be responsible for payments if the primary signer dies unexpectedly, it’s smart to take out a life insurance policy on the person and name yourself as the beneficiary. For example, if you cosign for your kid to purchase a $20,000 car, you’ll need a policy of at least equal value. This way, you can use funds from the death benefit to pay off any remaining loan balance.
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