Finance 101
April 22, 2021

Is Co-Signing a Loan a Good Idea?

Do you have a friend or family member who needs a little financial help but can’t get a loan on their own? In these sorts of situations, it’s possible that you might be asked to co-sign the loan. Co-signing a loan essentially means you’re agreeing to help with the loan payments if the principal borrower cannot pay. Before you decide to co-sign a loan, there are a few things you should ask.

Could You Pay the Loan Yourself?

The very first thing you should ask yourself is, “could I pay this loan if I had to?” When you co-sign a loan, you aren’t just lending a friend or family member your credit score. You’re actually promising to be responsible for their debt. You need to make sure you are in a financial place where paying the loan would not put excessive burden on you.

Of course, you ideally won’t pay a cent on the loan. However, in many states, the lender has the right to go after you for the payments. If the borrower misses several payments, lenders can sue you for nonpayment and require you to pay all sorts of fees and expenses. No matter how much you trust the borrower, you need to think carefully about your finances and ensure you could manage the loan payments if necessary.

What’s Your Current Credit Score Like?

When people start discussing the pros and cons of co-signing, your credit score is one of the main things that will come up. Co-signing a loan is basically like having your own loan. This means it can impact your credit score negatively or positively. As long as the main borrower pays the loan on time, you build credit. This can be a great thing if your credit is a little on the low side and you aren’t doing anything to build credit yourself.

However, if you’ve already got pretty decent credit, you might want to think twice. Any missed payments can cause your score to drop. Even if the main borrower is responsible, just taking on a co-signing role can cause a slight dip in your score. This happens because having more debt can cause your credit to decline briefly. Your score will recover quickly as long as the loan is paid. This is just something you need to be aware of before agreeing to anything.

How’s Your Relationship With the Person Asking You to Co-Sign a Loan?

Of course, no co-signing decision is going to be strictly financial. In almost all cases, the person asking you to be their loan co-signer is someone closely related to you. Whether they are a friend, a family member, or a loved one, your relationship is going to be affected by this question. If you are extremely close to the person, co-signing a loan might be something you will automatically agree to. For example, if your spouse comes to you for help, the idea of co-signing might be a no-brainer.

Just keep in mind that there’s always a little risk about getting involved in your loved one’s finances. If the person does not pay their loan and you end up having to cover their payments, it might lead to some resentment. Before you co-sign, you need to carefully think about whether you think your relationship can handle a worst-case scenario.

Do You Plan on Applying for a Loan Soon?

Even if you have a stellar credit score and the main borrower always pays their loan on time, co-signing can cause some problems. Any time you apply for a loan, the lender will carefully consider your income, current savings, and current debt. Being a co-signer counts as a debt since you are technically responsible for the loan. Therefore, you can end up finding it slightly harder to apply for future loans yourself.

This shouldn’t be a problem if you don’t have any plans to get a loan sometime soon. But if you want to get a house, car, or other big purchase in the next couple of years, your role as a co-signer can cause some issues. Make sure that being a co-signer will not interfere with any of your future plans before you go ahead and agree to help out a loved one.

Are Other Bad Credit Loan Options Available?

Since there’s quite a few potential downsides to co-signing a loan, it should usually just be treated as a last resort. There’s no reason to jump right to co-signing just because your loved one got turned down for a single loan. Make sure the person who needs a loan has spent time considering all their options.

Ultimately, co-signing a loan can help your loved ones get the financial assistance they need. You do need to be cautious since you are assuming responsibility for the loan. However, as long as the borrower pays on time, co-signing can be a beneficial option for both of you.