There may come a time when you are asked to cosign on a loan. What should you do? If a friend or family member needs a loan, but doesn't have good enough credit to gain approval on their own, they might be approved if someone with better standing signs on the loan with them. That's where you come in, if you agree. Before rushing into the situation, take time to consider these pros and cons. Spoiler alert: the cons tend to outweigh the pros.
PROS
You may help improve someone's life
The obvious positive of cosigning on a loan is that you get to help someone, which feels good. If this person is a family member, you may even feel that it is your responsibility to do so, for the sake of their happiness. A loan - particularly an auto loan or a mortgage - can make a big difference in the quality of one's life, so helping this person get the loan can have a major impact.
Your credit score might improve
Another potential benefit to cosigning is that you may even manage to improve your credit score. This certainly isn't always the case, but there are times when it can make a positive difference. According to nonprofit Take Charge America, "Although one of the lesser factors, having a variety of different types of credit accounts is one of the factors that determines your credit score. So if you’re cosigning for a type of loan you don’t currently have, it might be a good thing."(1)
CONS
You're on the hook
On the flipside, the most obvious negative to cosigning is that you are responsible for the loan if the main applicant isn't able to make their payments. If the payments cease, you could be in for an unexpected expense. This can be a serious burden, especially if it's a mortgage.
You can face legal action
ou won't only be on the hook with the bank if you don't make the payments, you'll also be legally responsible. You may even be sued. If payments cease, you will likely be the first one held responsible, since you were the one with the good standing to help them get the loan in the first place.
Your credit score can take a hit
If payments are late or missed, your credit score can take a hit just as it would if you were the one with the loan. It's essentially as if the loan is yours, even though you're not primarily the one making the payments.
Your personal relationship can take a hit
Even worse, your personal relationship with the other person can suffer. Arguments and bitter feelings can arise, and unfortunately, these can become permanent emotional scars in some cases.
You can get taxed on a settlement
If the loan isn't paid and the debt is written off by the lender, you can end up paying more in taxes. For example, if you owe $10,000 and the lender settles the debt for $4,000, you may have to report the other $6,000 as "debt forgiveness income" on your tax return. (Always consult a tax expert in a situation like this.)
Ultimately, when it comes to cosigning, the cons tend to outweigh the pros, but that's only if the person you're cosigning with isn't reliable. There are times when it makes sense to be a consigner, but be sure to have a serious discussion with the borrower, and make sure they understand how serious the consequences will be if they don't take responsibility. In the end, it's very much about trust.
If you would like to discuss this, or any other financial concerns, with our lending professionals, please feel free to let us know.
1. https://www.takechargeamerica.org/the-pros-and-cons-of-cosigning-a-loan/