Should You Co-Sign a Loan? 5 Things to Consider
As human beings, we have a natural desire to help others, especially those close to us. When it comes to money, a common way to help a loved one is to co-sign a loan for them, particularly if you have stellar credit.
However, before you co-sign a loan, make sure to do your research. While this can help their chances for approval, it can also put your own personal finances at risk. Here are five things to consider when deciding whether to sign on the dotted line.
Weigh the Risk vs. Reward
Generally, co-signing a loan is considered very risky with very little reward. When you co-sign a loan, you’re personally guaranteeing the debt. This means that if the borrower can’t make payments, you are obligated to make the payments. This is a big commitment to make, especially if the loan is for something (a car, house, education) that you’re not benefitting from. As a result, the decision comes down to your personal weight of the risk and reward. Objectively, co-signing is a major financial risk. However, your desire to help your loved one – often a child – may be enough reward. There is no right or wrong approach or decision, as long as you understand what you’re signing on to.
Think of the Relationship
Any time money becomes involved in a relationship, things can get messy. Co-signing for someone you’re not particularly close to could be a difficult journey to navigate. However, money can also hurt the relationships of people you’re closest to as well. When you co-sign a loan, you want the borrower to stay up to date on their payments to avoid any negative consequences for you. As a result, you may find yourself reminding them to make payments. This could rub them the wrong way and cause problems between you.
Additionally, if they do miss a payment (or multiple), you’ll have a negative mark on your credit. This could also create tension. If you do decide to co-sign, it’s crucial to have open and honest discussions beforehand. Set out terms that both parties agree to and put them in writing. Continue to keep the dialogue open throughout the life of the loan.
Consider Your Own Financial Goals
Co-signing a loan can have an impact on your financial goals, regardless of whether the borrower is making payments on time. Getting a loan for yourself while serving as a co-signer can be difficult. Often, lenders may decide that you have too much credit in your name and deny your loan application. Therefore, before you co-sign, consider whether you’re planning to take out a car loan or mortgage at any time over the course of the loan.
Track the Payments
When you co-sign a loan, you’re adding another due date to your bill calendar. While the borrower will likely be the one making the payments, it’s best for you to keep records as well. It’s in your best interest to ensure the payments are being made each month. As a result, that presents the organizational challenge of having one more financial item to keep track of, on top of your own bills.
Understand Tax Implications
If payments become difficult for the borrower and for you, the option to settle the loan may come up. If the loan gets settled, there may be tax implications. These tax implications would also apply to you as a co-signer. This is important to know because settled debt can be considered income on your tax return in certain situations.
While co-signing a loan is a generous act, it’s important to understand the consequences. The risks to your own financial situation are high. Be sure to weigh all of the possible ramifications before making a decision. And if you do decide to help your loved one, ensure that you keep an open dialogue to prevent negative consequences for both of you.
For more financial tips, visit the Tayne Law Group blog.