Loans That Involve Family Or Friends
Have you had a friend or family member reach out to you to co-sign on any particular loans? Before agreeing to do any favors, consider this responsibility very carefully. You not only run a risk of losing money, but also valuable assets.
- What is a co-signer?
- Why you may have to decline co-signing for a friend or family member
- Questions you should ask before signing any loans
- What to do if your personal relationship deteriorates
What is a Co-signer?
A co-signer is a person who agrees to pay a borrower’s debt if he or she cannot make the repayments at any point in the life of the loan. A co-signer typically has a higher credit rating and solid credit history, improving the chances of approval for the borrower.
However, co-signers are both jointly and individually liable for the debt. If the borrower fails to repay the loan, the co-signer is just as responsible as the borrower for repaying the loan in full.
Reasons you may have to decline
It’s best to consider all options before becoming a co-signer on any loan. Can you contribute to the borrower’s down payment, eliminating the need for a co-signer?
You will also need to plan or consider how you will pay back the loan if the family member or friend is unable to do so. Can you personally afford the repayments? Do you have savings and assets to use if you have to pay off that debt? Evaluate the risk of your personal financial future in the worst-case scenario before making that commitment.
Also, consider your relationship with the borrower. If something goes awry, how will your relationship fare? It may be best to just remove this commitment from their options to protect the integrity of your relationship.
The effect on your future loans and credit report
You will have to disclose to your creditors if you have co-signed on any loans when you apply for lines of credit in the future. They may take into account the repayments on the loan, even if you aren’t currently making them. They may also calculate it into your debt-to-income ratio, which can negatively affect their perception of your ability to repay a loan- and possibly end in the rejection of your application.
You may also end up with a poor credit report if you and the borrower both find you cannot repay the loan. If the loan becomes listed as defaulted, your credit report will reflect this information for many years, and ultimately lead to a lower credit score.
Questions you must ask prior to signing a loan
Before you co-sign on a loan, ask the creditor or lender the following questions:
1. What type of loan am I co-signing for?
Be cautious about loans that have no specific payback times.
2. What should I check if I am asked to co-sign for a business loan?
Learn everything you can about the business- including the business plan and the business’ financial state to determine if it has good prospects and good financial health.
3. Am I liable for a fixed amount or the total amount of the loan?
You’re better off with a fixed amount because you’ll know in advance exactly what you owe. If you owe the total, that includes the interest, fees, charges, and penalties associated with the account.
4. How much am I co-signing for?
The contract should clearly define how the amount of money you owe is calculated in the worst-case scenario of the borrower failing to make repayments.
5. Do I have to provide assets to secure the loan?
If the loan isn’t for personal, household, or domestic purposes, you may be asked to provide assets for security. This means your assets are available for liquidating in the event the lender seeks to recover any funds that will pay off a loan that the borrower defaulted on.
6. What should the loan contract tell me?
Get a copy of the contract from the lender. It should provide the following information:
- The amount of the loan
- The interest rate, fees and charges
- Whether the loan is secured with an asset
- The duration or lifespan of the loan
- The repayment amounts
What to do if a personal relationship deteriorates
The break down of a relationship has the potential to affect every part of your life, including your finances. If you were a co-signer on a loan for an ex-partner or friend, you may be held liable for their debts if they fail to repay them.
In most cases, you won’t be able to get out of the contracts you made prior to the deterioration of your relationship, but you can consult with a lawyer to find out where you stand, especially in the case of divorce.
Make sure you pause and carefully consider the weight of co-signing on a loan. If your friend or family member cannot repay the loan, you will be responsible for the debt. Take the same precautions you would take if you were personally taking out the loan for yourself.