Credit mishaps like a late or missed bill payment can stay on your credit report for years. People with negative credit events or short credit histories, such as recent high school or college graduates, often have trouble getting approved for loans. Cosigning is a way that you can help a friend or family member secure a loan, but it is extremely risky because you could end up paying the loan yourself.
When you cosign a loan, you agree to share responsibility for paying the loan with the primary borrower. Cosigning a loan essentially allows you to use your credit score to stand in for someone else. Lenders are hesitant to give money to people with poor credit scores; backing someone else's debt with your good credit score can convince lenders to make loans to someone with a low credit score. The main drawback is that the lender is free to collect money from you if the primary borrower doesn't pay a cosigned loan.
In many loan consignment situations, the primary borrower is expected to pay off the loan and the cosigner simply signs on as a favor to help the primary borrower get approved for the loan. Despite initial expectations, the primary borrower might miss payments or quit paying the debt completely. According to the U.S. Federal Trade Commission, lenders can attempt to collect payment from cosigners in the event of default, even if they haven't attempted to collect from the primary borrower first. In other words, you could end up paying for the entire loan if the primary borrower quits paying.
Other Risks of Cosigning
When you cosign a debt, you might have to pay pay late fees or collection costs in addition to the total amount of the loan. The lender can also sue cosigners in an attempt to garnish wages or property to collect missed payments. Missed and late payments on a cosigned debt can damage your credit score, even if you don't know that the primary borrower is missing payments. If the primary borrower on a cosigned loan files for bankruptcy, you can still be held liable for the entire debt.
When a friend or family member asks you to cosign a loan, think twice before you say yes. The Federal Trade Commission says that as many as three out of four cosigners are asked to pay cosigned loans that go into default. Even if a friend or family member intends to pay a loan, a lost job or some other unexpected financial difficulty could result in default.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.