Cosigning and what it risks

In short

A friend of mine once signed a loan for his nephew and figured it was only a signature. If you are thinking about cosigning, know that you become fully responsible for the debt. The lender can come to you first if the other person misses a payment. Late payments show up on your credit report just as they do on theirs. Ask the lender for the loan terms in writing before you sign anything. Set up your own alerts so you never learn about a problem by surprise.

The whole of it

What it is

I once watched a good man lose sleep over a loan he never used. He had signed for his daughter's car because he loved her and wanted her to have a fair start. That is the heart of cosigning, and there is no shame in wanting it.

When you cosign, you promise the lender that you will pay if the borrower does not. The lender is not asking for a reference. The lender is asking for a second person who is legally on the hook. You do not get the car or the house or the tuition. You get the risk and nothing else.

You have probably been asked at some point, or you may be asked soon. It usually comes from someone dear to you, and that makes it hard to think clearly. So it helps to know exactly what you are being asked to carry.

How it works

A young woman I know applied for her first apartment and got turned down. Her credit history was too thin for the landlord to trust. Her aunt stepped in and cosigned the lease. The landlord said yes, because now two people stood behind the rent.

That is the whole idea. A lender looks at the borrower and sees too much doubt. So the lender asks for a stronger name to sit beside the weaker one. Your credit and your income are what make the deal possible.

Here is the part that surprises people. In most cases you are equally responsible for the whole balance. The lender does not have to chase the borrower first. If a payment is late, the lender may call you the same day. If the borrower vanishes, the full amount can land on you.

The debt also appears on your credit report. It can count against you when you apply for your own loan. A lender may see that debt and worry you are carrying too much. Even if every payment is on time, that added balance is still on your record.

The Federal Trade Commission publishes a plain notice about this that lenders often hand to cosigners. It is worth reading slowly. It says, in plain terms, that you may have to pay the full debt if the borrower does not. The notice is part of a rule the FTC calls the Credit Practices Rule. That rule requires lenders to give the notice before you sign.

The numbers, and where to find yours

I once sat with a neighbor at his kitchen table while he opened a stack of mail. He had cosigned years earlier and never checked on it. He did not know the balance, the rate, or the due date. Numbers you do not know can hurt you.

Before you sign, get three facts. Ask for the amount borrowed, the interest rate, and the monthly payment. Ask how long the loan runs. Then multiply the monthly payment by the number of months. That total is the most you could be asked to pay, and it is often more than the amount borrowed because of interest.

You can look at your own credit reports for free. The three national credit bureaus are Equifax, Experian, and TransUnion. The site AnnualCreditReport.com is the one place set up by federal law for free reports. You can pull yours before you sign and again after. If the loan shows up, you will see exactly how it is being reported.

Ask the lender one more question. Ask whether the loan has a cosigner release. This is a way for your name to come off the loan after the borrower makes a set number of on time payments. Some loans have it, and many do not. Get the answer in writing.

A worked example

A woman named Carol had a nephew named Danny. Danny was twenty two and needed a car for a new job. His credit was thin, so the dealer asked for a cosigner. Carol had good credit and said yes.

The loan was for 15,000 dollars. The rate was 8 percent a year. The term was 60 months. The monthly payment came to about 304 dollars.

Let us check the math the plain way. Multiply 304 dollars by 60 months. That gives 18,240 dollars. Now subtract the 15,000 dollars borrowed. The difference is 3,240 dollars, which is the interest over the life of the loan. So Carol was agreeing to stand behind up to 18,240 dollars, not 15,000.

For eight months, Danny paid on time. Then his hours were cut, and he missed two payments. The lender did not call Danny first. The lender called Carol. She had 608 dollars to catch up, which is two payments of 304 dollars each.

Carol paid it. She was glad she had savings. But she also saw a late mark appear on her own credit report for a debt she never drove. Three weeks later she applied for a small credit card and was offered a lower limit than she expected. The loan was still on her record.

Carol did not blame Danny. She loved him. But she wished she had asked three things at the start. What if he cannot pay? Can I see the account online? Can my name come off later? Those are fair questions, and a good lender will answer them.

Where it goes wrong

You have probably heard that cosigning is just a favor. That story sounds warm, but it leaves out the risk. The trouble usually begins in small ways.

The first trouble is a missed payment. It does not take a crisis. A slow month at work can do it. Once a payment is late, your credit can take the hit too.

The second trouble is that you may not see it coming. Many cosigners do not get the monthly statements. The borrower gets them. If you do not ask for access, you may hear about a problem only when the lender calls. Ask for online access or email alerts at the start.

The third trouble is the strain on the two of you. Money and family can be a hard mix. I have known people who stopped speaking over a car loan. Talk plainly before you sign about what happens if a payment is missed. Agree who pays, and how you will tell each other.

The fourth trouble is that leaving is hard. Your name stays on the loan until it is paid off, refinanced, or released. Refinancing means the borrower gets a new loan in their name alone. The borrower must qualify for that on their own. Do not count on it.

Last, keep your own goals in view. If you plan to buy a home soon, this added debt may matter to a mortgage lender. Think about that before you sign. It is your credit too.

Questions to answer before you leave this page

If the borrower stopped paying tomorrow, could I cover the full monthly payment for as long as it took? Do I know the total I could owe, with interest, and have I written it down? Have I asked the lender for online access so I can watch the account myself? Does the loan offer a cosigner release, and what must the borrower do to earn it? Have I talked openly with the borrower about who pays if money gets tight? Would I still feel warm toward this person if I had to make every payment myself? And if the honest answer to any of these is no, is there another way I can help, such as a smaller gift, that would not put my name on the line?