You’re in a tricky situation: your friend, who you love and care about deeply, has come to you asking for your help getting a loan that they desperately need. You know the loan could benefit your friend, but you’re also unsure of the risks behind cosigning a loan.
The most important step you can take is to learn why cosigning a loan for a friend is rarely a good idea. That way, you can understand why you probably should avoid it.
Should you cosign a loan for a friend?
In general, you may want to avoid cosign a loan for a friend. Here’s why:
- You become legally responsible for the loan. In the eyes of the lender, the full loan amount is 100% yours. That means if your friend doesn’t make payments, the two of you will be held responsible.
- Your credit score could be affected. Should your friend miss even one payment, your credit score could be negatively impacted since the loan is considered to be in your name too. And if the borrower defaults on the loan completely, it could impact your credit score even more.
- You could damage your friendship. Consider the risks to the relationship with the person you are cosigning a loan for if they are unable to pay back the loan. Is the risk of ruining your friendship worth it?
- You could lose personal property. If a loan — such as a personal loan — requires any collateral, such as your car, house or other personal asset, you are at risk of losing your property should your friend default on the loan.
Reasons why you may or may not choose to cosign a loan
Here’s a more comprehensive look at reasons why you might choose not to cosign a loan:
- You can’t afford the loan. You should not take the risk on of cosigning a loan unless you can afford to pay the loan in its entirety. Otherwise, you could liable in court or even have your assets seized as part of your state’s collection practices.
- You need a loan for yourself. If you know you will need your own loan soon, cosigning a friend’s loan could prevent you from being eligible for a loan for yourself.
- You’re concerned about your credit score. If you’ve had a history of bad credit, are trying to build up your own credit or just don’t want to see your credit score negatively affected, you need to be aware that cosigning a loan could hurt your own credit score if your friend misses payments or defaults on the loan all together.
- Your friend has a history of bad financial decisions. You should know why your friend needs a loan. It’s within your right to decide that you won’t cosign a loan if you don’t agree with how they’ll use loan funds. If your friend tends to rack up debt, you’re also free to explain to your friend that you don’t feel confident they need the added debt.
That being said, there may be a few circumstances where it is acceptable to cosign a loan for a friend. For example:
- You can afford to pay the loan completely. If you cosign a loan, you are agreeing to be responsible for the loan amount in the event that your friend is unable to pay it. So, if you can afford to pay off the entire loan amount and are willing to do so, you could cosign a loan with less risk of hurting your own finances. Aside from the money you’d be out for the loan amount, of course.
- The loan is for both of you. If you are purchasing something together, cosigning a loan might be a logical move, as you will both be utilizing the item or asset. For family members, a parent might choose to cosign a loan so their child could potentially consolidate student loan debt at a lower interest rate.
- You’re willing to take on the risk. Maybe you feel like your friend has no other options, this is a necessary step and you are fully aware of the risks involved. In that case, cosigning a loan is a personal decision that only you can make.
How to protect yourself when cosigning a loan
If you do decide to cosign a loan with a friend or someone else, you should also take steps to protect yourself as much as possible before the loan is enacted. You can minimize your risk by taking actions such as:
- Don’t put down personal assets as collateral. If you’re willing to cosign on a loan, you shouldn’t wager more than that. Using your home, car or other personal asset as collateral only increases your risk.
- Establish expectations in advance. You should sit down with your friend to establish expectations for the loan and repayment. It’s helpful if you can set out a plan in writing about the consequences if your friend misses payments or is unable to fully repay the loan.
- Stay on top of the loan. Although it is recommended that you keep close tabs on the borrower to ensure that they are repaying the loan on time each month, you could also ask the creditor to inform you of any missed or late payments automatically. If the lender has an online system, you and your friend could also share the account information. That way, you could easily log into your account to review payment information.
- Try negotiating loan terms. Rules will vary by lender and state, but you may be able to negotiate what you’re responsible for as a cosigner, such as limiting your liability to the loan principal balance instead of the full principal and interest amount. You can also try to negotiate responsibility for late fees, attorney fees or accrued court costs.
Other ways of helping your friend
Outside of cosigning a loan for your friend, there may be other ways that you can help, such as:
- Assisting with a down payment. Perhaps you can’t afford to take on the risk of cosigning an entire loan for your friend, but you may be able to help them put together a down payment so that they may qualify for a conventional loan.
- Lend them the money directly. To ensure that you would not be legally responsible for your friend’s debt and to avoid possible damage to your own credit score, you could consider lending your friend the money they need directly, either as a lump sum or in installments. It is advisable to get all loan terms in writing and to have the loan contract notarized if you do choose to DIY a loan.
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