Your dearest friend, in serious need of money, comes up to you and requests that you co-sign a loan with him so he can qualify for a lower interest rate and a bigger loan amount. Being deeply moved by your friend's distress, you decide to be by your friend's side and cosign the loan without much prior thought.
Well, this is what most of us do when we find our loved ones facing hardships.
We give ourselves into emotions and rationality takes an oblivious back seat. But this is exactly where we unconsciously make ourselves vulnerable to the ill consequences of cosigning a loan. Thus, despite all the emotional edges,make sure you know how you will be responsible towards the cosigned loan, if the borrower fails to repay the loan or lands up filing for bankruptcy.
Here are a few things that you should consider when you cosign a loan with the borrower:
Your status will be that of a borrower: The loan that you have cosigned with the borrower will appear on your credit report, even though you have nothing to do with this loan. It simply means that you will be responsible towards the loan like the primary borrower. In fact, the primary borrower’s payment habits will potentially affect your credit ratings. If the primary borrower fails to make payments on time, there is a bright chance that the bank will chase you for money.
Your credit worthiness might be at stake: An additional loan on your credit report can be quite detrimental to your credit score. The fact that an extra loan can lessen your credit-to-debt ratio is indeed a matter of anxiety. The credit-to-debt ratio basically measures your debt liabilities in comparison to your credit limit. It is always advised that you maintain a wide gap between your credit limit and the debt you owe. The more you exhaust your credit limit, the more difficult it becomes for you to get loans in future.
Your sign is an agreement to pay: When you cosign a loan, you actually agree that if the primary borrower fails to repay the loan or files for bankruptcy, you will be liable for the repayment of the loan. The Federal Trade Commission, reportedly, affirms that about 75% of the defaulted loans are repaid by the cosigners.
You will be responsible towards all the loan terms: You will not only be responsible towards the loan money, but also towards each and every term of the loan you cosigned. Simply put, if the borrower cannot repay the loan, you will not only be responsible for repaying the principal but also for the interests and penalties that the loan carries. So, it is advised that while signing the loan, you make a separate agreement with the borrower and clear out your individual responsibilities towards the loan.
Create an emergency fund: The best way to avoid such unpleasant consequences is to create an emergency fund so you can make payments if the primary borrower fails to make the payments. Try and put aside a fixed amount every month, specifically for making payments on the loan.
Cosigning can be risky if you are not careful with it. However, there is nothing to feel that cosigning a loan is all nightmarish. All it demands is your understanding of the possible consequences that the loan can have. So, under all circumstances, do treat even a cosigned loan as a normal loan that you would sign. It will not only help you get a fair idea about the loan and its terms but also help you deal any troublesome situation tactfully.