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What You Need to Know Before You Cosign a Loan

What You Need to Know Before You Cosign a Loan

The desire to help others is very strong in a lot of people. This is particularly true when those others are family members. While it’s true one of the earliest lessons many of us get is family comes first; how far is that supposed to go? Should you really be expected to put your financial future on the line for another person—especially family? It’s one of the riskiest money moves you can make, so here’s what you need to know before you cosign a loan.

It’s Really Your Loan

When you agree to cosign a loan, you are—in effect—taking on the loan yourself and trusting the other person to service the resulting debt. If that person fails to do so, you’ll be 100% responsible for the principal, as well as all accrued interest and late fees that may have piled up during the period of time the borrower was defaulting on the loan.

In some cases, you‘ll be expected to bring the loan up to date, in addition to making all of the remaining payments on time. Some loans have clauses that require the entire debt to be paid in full if the loan goes into default. Always read the agreement before you decide to cosign, so you’ll know exactly what you’re getting yourself into.

It Affects Your Credit Score

When you cosign, the loan goes on your credit report as an obligation for which you are fully responsible. After all, if the primary borrower defaults, you will be responsible to repay it. This means the payment amount will be figured into your debt to income ratio. If it pushes your ratio beyond a potential lender’s acceptable range, you might be denied credit for your own needs.

Further, because outstanding obligations comprise 30% of your credit score, cosigning the loan could cause your rating to drop. Here’s the kicker though, if the loan is paid in full with no problems, the borrower will get the credit rating boost. Meanwhile, yours will remain the same as it was when you cosigned the loan. In other words, you’ll take all of the risk, but get no reward—other than the borrower’s gratitude.

You’re Responsible Until the Debt Is Paid

Unless the loan includes a timeliness of payments clause, your name will be attached to that loan until it is paid in full. Before you sign the agreement, ask if a cosigner release clause can be included. The only other way to get your name off the loan is for the borrower to qualify to refinance based upon his or her own history.

Another Way to Help

Sometimes, refusing to cosign a loan is the best thing you can do for someone, as it will push them to stand on their own. Rather than helping them to go deeper into debt, you could suggest they work with a debt settlement company to improve their finances—if that’s the issue.

In addition to evaluating their financial situation, companies like these may be able to help them save money and get out of debt faster. Just make sure they consult information like these Freedom Debt Relief reviews to get a sense of the credibility of the company with which they choose to work.

So that’s what you need to know before you cosign a loan. And frankly, most people will tell you it’s a bad idea. You’ll be looking at a lot of risk with minimal upside. Every financial analyst out there considers that a bad investment.

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by Rebecca Jones // Contributor to Businessing Magazine.

Opinions expressed by contributors are their own.