Co-signing a loan for a friend or family member can be a feel-good experience. On the other hand, adding your name to someone else’s financial obligation is a huge responsibility that can be devastating to your credit. So is co-signing a loan the right thing to do? Only you can make this decision.
Whether it’s a car loan, mortgage, student loan, or apartment lease, adding your signature to someone else’s promise to pay is nothing less than your commitment to take responsibility for that borrower’s debt if that borrower fails to meet its obligations. Engagement is serious business and can affect many aspects of your financial future. Here’s why.
First, there are many reasons why a borrower may need a co-signer. Maybe your child doesn’t have a credit history and needs a “helping hand” to start their financial life. In this case, the benefits of co-signing may outweigh the financial risks associated with putting your good credit on the line. Alternatively, a person may need a co-signer because they don’t have enough credit to qualify on their own. Will adding your commitment to support them financially change their bill paying habits? In many cases, the answer is no.
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In general, the risks of co-signing a loan outweigh the benefits. For example, adding someone else’s debt to your existing obligations can easily impact your Debt-to-Income Ratio, or DTI. DTI is the ratio of your debt payments to your income. Someone who earns $ 4,000 a month and has debts of $ 1,500 a month has a DTI of 37.5%. Co-signing for someone who accepts a payment of $ 500 per month for a vehicle or home loan or lease increases the co-signer’s DTI to 50 percent, which could easily prevent the co-signer from qualifying for a vehicle or a mortgage.
Another disadvantage of co-signing is the possible reduction in the credit rating of the co-signer. Because lenders do not notify a co-signer when the primary borrower makes a late payment, misses a payment, or stops paying altogether, it may take many months before the co-signer realizes that the lender’s indiscretions principal borrower had a negative impact on their credit rating. This is because 35% of a person’s score is based on that person making their payments on time.
Co-signing can also lock in the credit of a co-signer for an extended period. Once a co-signer signs on the dotted line, they are usually obligated to stay on the loan until the loan is paid off or refinanced on behalf of the primary borrower. The obligation to pay can be as short as 3 to 6 years for something as simple as a car loan, or as long as decades for something as intimidating as a 30-year mortgage. And, in the event of incapacity or death of the primary borrower, the responsibility for repayment rests entirely with the co-signer.
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Co-signing isn’t the only way to help a friend or relative build or improve their credit. Adding the person as an additional cardholder to one or more of your credit card accounts is an easy and secure way to establish or add positive lines of credit to someone’s credit reports. else without affecting your credit. The key is to maintain control over the use of the card by denying access to the other person or by placing strict controls on the card. The other person can also establish their own line of credit using a secured credit card, which limits the use of the credit to the amount the person deposits in the secured card account.
That great credit score you’ve spent years building can be negatively affected if the person you’re co-signing on doesn’t meet their end of the bargain, so think carefully before you grab that pen.
See you at closing!
Gary Sandler is a full-time real estate agent and president of Gary Sandler Inc., real estate agents in Las Cruces. He loves to answer questions and can be reached at 575) 642-2292 or [email protected]
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