How to Know When It's OK to Co-Sign a Loan

Filed under: Student Loans, Investing Basics, College, Loans

It's not easy qualifying for lines of credit these days, and in order to do so, many millennials are turning to family members for a leg up. A recent survey of 18- to 30-year-olds by Experian Consumer Services, which provides credit monitoring services, shows that nearly two-thirds of them have used a co-signer in the past, and three-quarters say they would ask their parents to co-sign for them in the future. The survey shows that millennials needed cosigners for:

• College loans: 35 percent
• Residential leases: 32 percent
• Car loans: 19 percent
• Legal agreements for credit cards: 17 percent
• Car leases: 11 percent
• Home loans: 6 percent

The trend is also reflected in an April report on student loans from the Consumer Financial Protection Bureau. It concludes that 90 percent of private student loans in 2011 had a cosigner. One issue noted by student loan borrowers was that although the lenders say cosigners can be removed from a loan after a specific number of on-time payments, getting the lender to actually do it is a complicated process. Worse, the lenders often use the death or bankruptcy of the cosigner as a trigger to require immediate full repayment of the loan from the borrower. But even if it doesn't come to such extremes, co-signing is not something to be taken lightly.

Co-Sign or No-Sign?​

When you co-sign for a loan, that debt will also appear on your credit report. But the real concern is the most basic one: Co-signing a loan or credit application means you're agreeing to pay the debt in its entirety if the main borrower defaults on the loan, becomes disabled or dies.

According to Experian's survey, most borrowers with a co-signed loan responsibly handle repaying it. But 8 percent net total of co-signed contracts are in bad standing because of late payments, missed payments or a default.

"It's important to recognize that you're making a high-risk decision, not just doing a good deed if you co-sign a loan," says Susan Tiffany, director, personal finance for adults at the Credit Union National Association. "The idea is that you're helping out your kids or your parents, but it has implications for you, too. You need to consider the fact that if someone needs a co-signer, it's because they've already been denied credit on their own and are considered a high risk."

In fact, Tiffany warns, in some states, debt collectors can go after a co-signer before pursuing the primary borrower for a debt.

Becky Frost, senior manager of consumer education for Experian, offers the following tips for parents, grandparents or other relatives contemplating co-signing a loan:

• Use discretion. Before you co-sign for anyone, be absolutely certain that he or she is capable of responsibly managing the account and will always pay bills on time.
• Have "the credit talk." Explain how credit works. It's important for the young person to understand that late payments, a maxed-out account or collections will affect both your credit scores and your ability to qualify for loans in the future.
• Stay in touch. It's important to maintain constant communication with your child to ensure that payments are being made on time and in full. The lender is not required to notify the co-signer about late payments or a delinquency.
• Consider the timing. If you're planning on applying for a loan for yourself in the next six months, it may not be a good time to co-sign for your child. With mortgages in particular, it's not a good idea to take on a new debt just before or during the lending application process.

"If you do choose to co-sign a loan, then you need to do some soul-searching and some pencil-sharpening so you know that you're co-signing for an amount you can absorb if you would need to," says Tiffany. "Make sure you're aware of the status of payments and find a way to monitor them before things get completely out of hand. Each individual has to make a decision about whether to co-sign or not, but it's important not to have any illusions about what you're doing and the risk you're taking."

Michele Lerner is a Motley Fool contributing writer.

 

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