The Down Side of Co-Signing a Loan

Business handshake after contract signatureOver the last week I’ve heard quite a few stories from people that have been burned on a co-signed loan, and had their credit score completely destroyed through the actions of another. Worse yet, in most of these situations, the person didn’t even know that a debt they had co-signed on had been neglected.

This means that they didn’t even realize that their credit score was being wrecked while it was happening. Essentially, they didn’t even have a chance to defend their good reputation as a borrower. Inspired by these true stories, I want to use this article to describe the full implications of co-signing on a loan, and how it is that we can keep track of debts with our names on them.

The most important thing to remember when co-signing for loans is that this debt will belong to both the primary applicant and the co-signer throughout its term. No matter what sort of agreement is made between the two parties, a co-signer is explicitly agreeing to take responsibility for the liability in question in the event that the primary applicant fails to meet the application.

This means that every late payment, delinquency, and submission to collections goes on both credit bureaus in real time. What’s more, there is no warning mechanism for the co-signer to rely on to see that the co-signer is not making payments. It is up to the co-signer to ensure that the payments are being made by the primary borrower, and to essentially protect their own credit score.

Understanding just how much our credit score is at risk whenever we co-sign for a loan application, we are in a position to begin establishing some ground rules for determining when and how to co-sign for a friend or family member’s loan. Firstly, we need to determine what kinds of applications we want to support. As a general rule, it is safest to support only those applicants with a strong income, but need to leverage your credit score or net worth.

Because a strong income can improve net worth by paying off debts, and credit score by supporting the borrower’s ability to make payments, the primary applicant is more likely to keep your credit score intact than if they were not financially able to meet the obligation in the first place. What’s more, because of the way in which a co-signature supports the application, it will re-enforce the primary’s ability to make repayments in that it will likely reduce the interest rate that is qualified for, and therefore reduce the payment obligation all together.

The second set of measures to take when co-signing for a loan application is to make sure that you have a way of verifying that the debt is being serviced in a timely manner. The best way to do this is to have the primary applicant provide you with some sort of verification that payments are being made every month. This can be as simple as taking a screenshot of the confirmation codes for each payment that is being made from online banking.

Alternatively, we may insist that a pre-authorized payment plan be set up to ensure that the payments are on time. If we wanted to be particularly hands-on, we could even insist that the debt be paid out from a joint account, which would allow you the ability to jump in and make a payment at the last minute, should things start heading south.

Regardless of how it is that we choose to defend our credit scores, it is important to remember that the most critical part of an applicant’s ability to pay off their obligations comes from their personal character. There’s no point in co-signing for a debt that we know is attached to an unreliable person.