Read This Before Co-Signing a Loan

Good Deed or Risky Business? Read This Before Co-Signing a Loan

Co-signing puts you and your credit score at risk if the primary borrower doesn't repay. Know the loan terms, have a written agreement and monitor your credit to avoid surprises.

Someone with a limited credit history, a low credit score or who’s just starting out, might not qualify for a loan on their own. Having a co-signer can help a borrower get approved and build both parties’ credit history. Win-win, right?

Maybe not.

Experts say you may be in for a massive financial headache if you co-sign without fully understanding the risks involved.

Here’s what to know before you agree to co-sign someone else’s debt.

What being a co-signer means for your finances and credit

Being a co-signer means taking responsibility for a loan someone else will use.

Co-signers serve as a backup for borrowers who’d otherwise struggle to qualify on their own. A co-signer with a solid credit score and history mitigates a lender’s risk of lending to a primary borrower who might have less-than-stellar credit or an insufficient credit history.

“The pro side is that you’re helping somebody and if they do a good job [repaying the loan], it’s going to have a positive impact on your credit,” says Jeff Schwartz, executive director of Consolidated Credit, a non-profit debt management agency.

But there’s a big catch in the fine print: If the primary borrower fails to make payments or falls behind, the co-signer is legally responsible for repaying the debt in full. That’s where your finances (and the relationship) may be tested.

If the account becomes delinquent or goes into default, the co-signer’s credit report and scores take a hit along with the person they co-signed for, says Julie Kuzmic, senior compliance officer, consumer advocacy at Equifax Canada.

What’s more: A delinquent account stays on your credit report for six years, hurting your own ability to get approved for other financial products.

With a secured loan attached to collateral (like a house, car or boat, for instance), the lender can take possession of the asset and resell it to recoup their losses. If there’s a shortfall after they’ve collected on the collateral, then a co-signer may also be on the hook for paying that, along with legal fees and other loan charges, Schwartz notes.

When doing good puts more than your finances at risk

Co-signers may think they’re doing something helpful (and they are) but, in some instances, that good deed can backfire, often with devastating and far-reaching consequences.

“In Canada, landlords are allowed to look at credit histories with consent from the applicant,” Kuzmic explains. Being the co-signer on a loan might affect your ability to be approved for a lease in the future.

She adds that some employers might pull your credit report as part of an employment background check. If you co-signed a now-delinquent loan or your credit score tanked because of it, potential employers could see it as a red flag, impacting your future job prospects.

Kuzmic says she routinely sees the havoc co-signing can wreak on the finances, credit, and relationships of consumers who reach out to the credit bureau for help. In a recent case, a mother who had co-signed on her son’s car loan to help him out, learned she was responsible for repaying the loan when he fell behind on payments.

Kuzmic says the mother had never even been in her son’s car or driven it, but suddenly found herself on the hook for the entire debt.

“[There’s] devastation that can come along with that, especially when somebody didn’t fully understand what they were agreeing to,” Kuzmic says. “So really think through the potential implications, and not just on the financial side. What happens to your relationship with this person?”

Tips for co-signing safely

If you’re considering co-signing for a friend or relative, here are some tips to do safely — and protect your financial health in the process.

Only co-sign for people you trust

Never co-sign for someone you don’t know. And even if you know the borrower, set clear boundaries on how the co-signing relationship will work, Kuzmic says.

If you know someone who has a spotty track record managing debt or paying their bills, don’t co-sign for them.

Communicate openly and candidly

Before agreeing to co-sign, have an honest discussion about the expectations you have of the borrower and potential risks.

Discuss how you’ll handle repayment if the borrower loses their job or encounters another financial hardship, Kuzmic suggests. Remember: You’re fully responsible for making payments as a backup in those scenarios.

Read the fine print carefully

Know what you’re signing up for, including the monthly payment amount, loan term, interest rate, repayment schedule and what your liability entails, Schwartz says.

As a co-signer, you’re financially obligated to repay the loan, but you aren’t entitled to any ownership stake if the loan is secured by collateral such as a car, house or other item.

Get everything in writing

Consider having a lawyer draft a co-signer agreement that both you and the borrower sign. This document lays out your mutual responsibilities and expectations and outlines what happens if the borrower defaults or falls behind on payments.

Maintain a financial buffer

Make sure you have enough money to cover the loan payments yourself if the borrower runs into trouble.

It’s best not to co-sign if you’re already carrying a high debt-to-income (DTI) ratio. Why? Co-signing for someone else will make it harder for you to qualify for a loan if you need financing due to your DTI ratio already being on the edge, Schwartz points out.

Keep tabs on your credit

Pull your credit report and scores from TransUnion and Equifax after co-signing so you can stay on top of any changes.

If the borrower misses a payment or defaults, you’ll see that negative entry on your credit report, usually 30 days after the account goes delinquent.

Contact the lender and the borrower immediately if you learn about late payments to figure out a solution.