Co-signing a loan? Here's why it's usually a bad idea

What is a co-signer?

A co-signer is someone — usually a relative or friend — who puts their own credit on the line to help someone else get approved for a loan.

Say your child doesn’t have enough of a credit history to be approved for an auto loan, or the best man from your wedding has such a low credit score that a bank won't give him a student loan for graduate school.

When you agree to be a co-signer, you stand behind the primary borrower and guarantee that the lender will be paid. Your stronger credit helps your friend or family member get the loan, and you agree to share in the responsibility.

A co-signer is sort of a human version of collateral. If a payment is missed or the loan goes into default, the lender doesn't take a house or a car, but it can demand your money, because the financial commitment becomes yours.

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How do you co-sign?

Together, you and the primary borrower complete a loan application, either in person or electronically, and the lender will send you a copy of your specific obligations and role in what's called a co-signer’s notice.

States have different laws surrounding co-signer rights, so make sure to research how things work in your state ahead of time.

The act of co-signing itself won’t damage your credit, but the loan will appear on your credit reports as soon as it becomes active.

Since you are as liable for the loan as the primary borrower, your credit history will be reviewed as part of the loan approval process — and can be impacted by the loan later on.

A benefit of being a co-signer

For the co-signer, the major upside is that you help someone in need who would not be able to get a loan, a lower interest rate or a higher borrowing limit without your support.

A young person new to credit or borrowing or someone older who has bruised their credit can have a difficult time finding a willing lender without a co-signer.

When you agree to back a loved one or friend on a loan, you can make that person's life easier and help with their financial goals.

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Reasons not to co-sign a loan

But far too often, co-signers regret their decision.

A 2016 survey of more than 2,000 U.S. adults found that more than a third (38%) of co-signers were stuck paying back all or part of a loan.

Co-signing isn’t just a matter giving over your reputation or verbal support to help a borrower. It also involves taking on significant financial risk and putting your credit in jeopardy. Here are five reasons never to co-sign.

1. When a loan isn't paid, it becomes your responsibility.

If your primary borrower misses a payment or stops paying altogether, then the loan falls to you.

You need to pay it back yourself or risk damaging your financial standing.

2. The loan can hurt your credit score.

If loan payments are late or are made in spotty fashion, your credit score can get knocked down a few pegs, making it difficult for you to take out loans of your own. The 2016 survey found more than a quarter of co-signers (28%) saw their scores drop.

But your score can be hurt even if the primary borrower is diligent with payments. A high unpaid balance on a loan you co-signed can hurt your credit utilization ratio, which is the percentage of your available credit that's in use and is a major part of your credit score.

When you're a co-signer on your loan, you'll want to take a free look at your credit score, just so you're aware of what's going on.

3. You could be sued.

When a loan remains unpaid for too long, both you and the primary borrower can be sued by the creditor or a collection agency.

If you have more financial resources than the person you co-signed for, a court could order you to pay the total loan amount because you gave your consent to be held financially and legally liable.

4. You’re on the hook for a long time.

If you're the co-signer on a long-term loan — like a 30-year mortgage — your obligation can last for decades.

This means you'll be connected to the primary borrower for years and years and may feel the need to keep an eye on that person's finances, so that some day far off in the future you won't suddenly find yourself hit with the monthly payments.

5. Co-signing ruins relationships.

Having to micromanage a loved one’s spending so you don’t end up saddled with loan debt will inevitably put a strain on your relationship.

A simple signature could end up damaging the dynamic between the two of you. And it will get much worse if your relative or close friend ever decides to walk away from the loan.

Co-signing alternatives

If you feel that the risks of co-signing are just too high, you have other ways to help someone close to you who's in a financial bind.

1. Lend the money yourself.

Well, maybe not a large amount. After all, the idea is to avoid the possibility of losing a lot of money. But fronting a bit of cash for a friend in need might be very helpful and appreciated.

The borrower won't have to stress about qualifying for a loan or the disastrous financial consequences of defaulting.

2. Help find other financial options.

If your son is asking for help on a student or auto loan, and you're not comfortable with co-signing, try pointing him in the direction of grants and scholarships, or low-credit lending options he might qualify for.

It can be a tough conversation when someone asks you to co-sign and you have to refuse — but ultimately, you can say no and that's usually the smartest answer.