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Top 5 Things to Consider Before Cosigning a Loan

So a friend or family member comes to you because they can't get a loan. Their credit score or income might be too low or their existing debt is too high. Whatever the reason, they've asked you to cosign a loan with them.

What Does Cosigning a Loan Mean?

When you co-sign a loan, you promise to pay off somebody else's debt if the borrower stops making payments for any reason. In the case of the friend or family member mentioned above, it means that they are a high-risk candidate and the lender needs to know that if they can't pay the loan, you will step in and make the payments. This not only helps the applicant get a loan, but it might also help them get a lower interest rate and fees.

Since your loved one gets a loan and you feel great about helping them, it's a win-win for everyone, right? Not always. There are a few things to think about before you decide to cosign a loan.

Five Things to Consider Before Cosigning

1. Your Credit Score Could Be Impacted

Let's say you cosign for a friend, and while the loan is still outstanding, you need a loan for yourself. You might find that your application gets denied because your credit score is too low as the co-signed loan information is reported on the credit reports of both loan applicants. The credit inquiry, balance and newly opened account can reduce points.

Another scenario could be that your friend doesn't pay the loan payments on time. Since you cosigned the loan, this late payment history will be reported to the credit bureau and negatively affect your credit score.

2. Your Savings Might Suffer

You've worked hard to save money for things you need now or for your future retirement. What's going to happen if the person you cosigned with loses his or her job or gets a pay cut and can't make full payments on the loan? Do you have enough money coming in every month to pay the loan, or will you have to dig into your savings so you can make the payments? If you have to go into savings (or stop your savings plan), that could have a huge effect on your financial future.

3. You Could Lose an Important Family Relationship or Friendship

When you first cosign a loan, everyone is pretty much happy. You're helping out a family member or friend, and that person is getting the loan they need. That's what's known as the "honeymoon period." As with many financial relationships, that period doesn't last very long.

If the person who needed the loan makes on-time payments every month for the duration of the loan, then all is well. However, if one or more payments are missed or late, and you have to make sure the person is making payments constantly, the relationship can get rocky. One missed, or late payment can create problems for your credit, and that puts a strain on any relationship, no matter how close you are at the start.

4. Should Things Go Bad, They'll Come After You First

Sounds strange, right? If your friend or family member borrowed the money and didn't pay it back, the first person the lender comes after is you. Why? Well, by cosigning the loan, you are the one that enabled the defaulter to get the loan initially. They'll assume this person doesn't have the funds to make the payments, so you're the first in line to get contacted and potentially sued.

5. Be Sure to Get Copies of All Important Documents

There's no doubt you want to trust the person with whom you're cosigning fully. However, you also have to watch out for yourself at all times. That means it's important to get hold of all documents you might need in case there's a dispute between your cosigner and the creditor. Make sure you get documents like the loan contract, Truth-in-Lending Disclosure Statement and all warranties (if you're cosigning for a purchase).

So think twice or three times or more when a friend or family member asks for you to cosign a loan. Saying "yes" might feel good for the moment but can lead to negative consequences for both your relationship and financial status.

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Rob Kaufman

Rob is a writer... of blogs, books and business. His financial investment experience combined with a long background in marketing credit protection services provides a source of information that helps fill the gaps on one's journey toward financial well-being. His goal is simple: The more people he can help, the better.