We’ve all been there. Whether you’re just starting to build your credit score or you’ve had a few hard knocks along the way and you need a helping hand to get a new loan, a co-signer can be a welcome sign of relief. It’s easy to score a federal student loan these days. You fill out the FAFSA, and before you know it, you’ve got cash in your hands. However, trying to get a car loan when you’re low on cash or your credit score is less than stellar can be a whole other story.
According to a recent study by Princeton Survey Research Associates International for Creditcards.com, about one in six U.S. adults have co-signed a loan or credit card for someone else. About half of those who co-signed did so for a child, stepchild, or distant friend (yikes). Auto loans accounted for a whopping 51% of all co-signings, followed by 24% for personal loans, 19% for student loans and 16% for credit cards.
Sure, co-signing has its pluses: you get to lend your credit score, employment history and even your bank account balances to a borrower that you would like to help. However, before you decide to sign on the dotted line, there are three reasons you might want to avoid being a co-signer altogether.
Credit score tank
Credit scores can be a bit of a mystery for most people, but what you need to know is that your credit score is unique to you, like your DNA, and it’s one of the most important facets for your entire financial future. If you want to apply for a loan, you’re going to need a solid credit score to come out a winner in the interest rate game. Scores range from 300-850, with lower interest rates for loans awarded to those with credit scores north of 740.
If you haven’t checked your credit score lately and are thinking about co-signing a loan, now’s the time to find out your magical three-digit number. You can quickly check your credit score with companies like Credit Karma in a matter of seconds.
Why does this matter? We’ve already established how important your credit score is. By co-signing for a loan, you are essentially lending your credit score for a period of time. If the person pays the bills every month you won’t notice any difference (other than maybe a minor adjustment to your credit score due to the new loan). However, if for some reason they skip a payment or do not pay the bill altogether, then your credit score could suffer a terrible demise.
Bottom line: Before you sign on the dotted line for someone else, understand the risks to your credit score and the impact that might have on your loans and available credit in the future. You may be happy to lend your credit score, but you would rather not watch your credit score tank faster than the stock market did in 2008 if the borrower decides to skip a few payments.
Losing your emergency fund
An emergency fund – a fund with three to six months of savings to cover your fixed expenses – should be a financial priority before you start saving for your month-long exotic vacation in the Bahamas. Just as the name applies, an ER fund is there to act as a life vest should you hit a financial emergency like losing your job, need to replace your roof on your house, or even if the person you co-sign for decides to stop making their loan payments abruptly.
“If you absolutely have to co-sign, then at least be aware there’s a sizable chance you’ll lose some money and/or get your feeling hurt,” states Matt Schultz, CreditCards.com’s senior industry analyst. According to the Princeton survey, 38% of co-signers had to pay some or all of the bill that the borrower just decided to stop paying.
Without an ER fund, it’s easy to see how you could go into deep debt if you suddenly had to find an extra $300 or $500 or more a month in your budget to cover the costs of the loan.
Bottom line: If you’re going to co-sign, make sure you beef up your ER fund to cover at least a few months of the new loan payment just in case you are left high and dry by the borrower. While you might recoup the lost funds down the line, you’ll want to make sure you keep your finances in check no matter what.
Breaking up (with loans) is hard to do
Relationships are tough. When you combine the elements of relationships and money, relationships can become even more challenging, if completely broken. Could you imagine how you would feel if you co-signed for an ex-boyfriend or an ex-girlfriend and now you are no longer together, and yet still tied together financially? Sounds like a recipe for disaster.
Many people don’t think about the relationship elements of being a co-signer. For all the reasons we’ve already discussed, as a co-signer, you are entering a financially binding relationship – good or not so good. If the borrower decides to skip a few payments, you are still on the hook. You certainly can’t call the lender up and say, “Whoops, I didn’t mean to co-sign on that loan, and now we are no longer together. Is it okay if I just take my name off the loan?” Not a chance that will happen easily.
Bottom line: You have responsibilities when you become a co-signer. It might feel like a passive relationship, but it can become very active if the borrower decides to renege on their agreement to the loan. Make sure your relationship is strong enough to tackle the co-signer responsibilities before you agree to the terms of the loan.