Should You Ever Cosign on a Loan, Credit Card, or Lease Agreement?
As a young adult fresh out of college with no credit history and a less than compelling employment history, my apartment renting prospects were grim. Like many in my situation, I had to ask my parents to cosign on that first lease.
Cosigning isn't limited to sad apartments in the San Fernando Valley, though. Around 7% of parents in the US have cosigned on their child's mortgage. For an applicant with poor or unestablished credit, cosigning can be a lifeline. For the cosigner, however, it's an arrangement that comes with a lot of risks.
So when is cosigning necessary, what are the risks, and is it ever the right move for you? Here's what you need to know.
Why do lenders require cosigners?
Cosigning a loan or application (usually for housing or utilities) means that you’re essentially acting as a guarantor on the transaction – if the borrower or applicant doesn't fulfill the terms of the agreement and make payments as they're due, you’re on the hook. You either have to make the payments yourself or your credit takes a hit, the same as if you'd taken out a loan yourself and neglected to make payments.
The most common reason why anyone would cosign on a loan or credit card or rental application is because the actual borrower isn’t a strong enough candidate on their own. They may have poor credit. Their income may not be sufficient. There can be any number of reasons. The cosigner is using their good name (and good credit, most often) to back-up the transaction. That’s why the majority of cosigners are parents. They can use their credit history and established incomes to help their children receive better loan terms or find better housing options.
As lenders have moved to reduce their risk (especially in the fallout of the Great Recession of 2008) they’ve tightened their standards for lending. If young adults haven’t already been working on building their credit history they may find themselves facing an uphill climb.
Therefore, it’s pretty understandable why parents jump into the breach to help their children. If they feel they can leverage their credit history to help their children obtain student loans and an apartment in a preferred neighborhood, they’ll do it – even if it’s not in their own best interests.
What are the risks of cosigning a loan or lease?
Loans and credit cards come with similar financial risks. Your credit can be damaged if you miss payments. Interest charges can make the debt grow. An unpaid debt may eventually be turned over to a collection agency. You could even be sued.
All of these outcomes are on the table when you cosign for someone else, with the added caveat that you may not even know these things are happening until it's far too late.
While your intent as a cosigner may simply be to help someone overcome an underwhelming application, you are equally as responsible for what happens with that loan, credit card, apartment, etc. You carry all of the risks and responsibilities that come with borrowing money or renting an apartment, with none of the perks, like being able to use that money or live in that apartment.
That's why, in general, most experts say just don’t do it when it comes to cosigning. It can cost you money, it can hurt your credit, it can strain your relationships, and it can get you sued. In fact, lenders are more likely to sue the cosigner to recover a defaulted loan. Why? Because the cosigner is much more likely to have the financial assets available to repay the defaulted loan.
Basically, cosigning means becoming directly impacted by a loan or agreement that you don’t directly control, and that can be a very bad gamble to make.
Should you ever be a cosigner?
While it's easy to say never cosign a loan, that's a pretty hard line to take, especially when it comes to the happiness, comfort, and success of your children or grandchildren.
The solution might be something in between. Avoid cosigning whenever possible. Look for alternate solutions. If cosigning is the difference between a great apartment and a pretty good apartment, then pretty good needs to be good enough. If it’s the difference between any apartment and no apartment at all, then consider cosigning with the condition that you maintain an open dialogue about finances to help ensure that the renter never falls behind.
Cosigning should be left as a last resort, but it can be an acceptable option if both parties are willing to be open and honest about money. If you trust your children enough to cosign on a loan, then they need to trust you enough to let you know that they’re struggling to make payments and why that is. Make money a safe topic of discussion from an early age and you’re less likely to run into the kind of unpleasant surprises that cosigning can lead to.
Dealing with debt from a cosigning situation that went sideways? We can help. MMI offers customized repayment plans to help you save money and get out of debt quickly. With MMI, you can be out of debt in as little as 24 months. Learn more.
