The following is a guest article written by the folk at Directbanc.com, your ultimate shopping destination for unique, low interest rate credit cards and financial services.
Let’s begin this with the final word on the subject: It’s never a good idea to cosign for a loan or credit card. 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. It will most likely be your child, but these days there seems to be a growing number of friends in need. When that happens, it’s very important to consider that more than two-thirds of people who cosign for a loan end up making the payments. Why? Let’s think about why people need a cosigner to begin with.
Lenders will require someone to cosign for a loan applicant when they determine that the applicant’s credit doesn’t meet its requirements. Essentially, the lender doesn’t believe that the applicant has demonstrated the ability, or perhaps even the responsibility to repay the loan on their own. If someone of good credit standing cosigns for the loan or credit card, the lender is more than happy to take the business. To the lender, a cosigner is a guarantor of payment on the loan. If they are unable to collect from the borrower, they know they can go to the cosigner.
All of the Liability with No Control
When you cosign for someone, you are essentially acknowledging that the borrower, be it your kid, a relative or a friend, is not considered to be a good credit risk by the lender. The question you have to ask yourself is, “Would I invest in a stock that the expert analysts have determined has a better chance of going down in value than up?†The answer for any reasonable-minded person would be no. With a cosigned loan, the lending experts are telling you that there is a greater chance the borrower can’t repay the loan, so be prepared.
Many parents really want to help their kids get a start in life, and whether it’s to buy a car or a house, or help them consolidate some high interest debt, it seems, on the surface, the right thing to do to agree to cosign on a loan. Here’s the problem: As a cosigner, you have no power or influence over the terms of the loan or credit card. If the card company or lender decides to increase the credit limit, you won’t even be informed. If your kid falls behind on payments, you won’t know about it until after it has been reported to the credit bureaus. In the worst case, should your kid decide to skip out on the loan, you are liable for the payments.
Helping the Kids
The better option for parents intent on helping their kids is to go on the loan as a joint borrower. With an auto loan, you should include yourself on the title so you have control over the vehicle. The same goes for a home loan. With some credit card companies, parents are given some permissions as a cosigner with regards to restricting credit limits. With online account access and free credit monitoring services, you should be able to keep a tight leash on your child’s activities.
You Need to Protect Your Credit
In the case of a friend or relative, it almost never makes sense to cosign. Unfortunately, when a friend or relative approaches with a request, they put you in a lose-lose situation. It’s best to politely explain that you don’t mix business with personal relationships. In the end, you need to protect your good credit.
(note from Joe – I read elsewhere of a parent who co-signed a credit call with a $500 line. The card issuer raised it to $20,000 over time and of course, the kid defaulted. I was pondering how to turn this into an interesting article, when Directbanc contacted me to offer this great post. FCC disclaimer, I was not paid to host this article.)