Credit, Cosigning and Bankruptcy: What You Need to Know
If you’re thinking about cosigning a loan for a friend or family member to help him qualify for better interest rates or a greater loan amount, make sure you know your responsibilities if the borrower is unable to make payments or ends up in bankruptcy.
This post from WiseBread.com provides a reminder about the responsibilities of a loan cosigner. Here’s a recap and expansion.
Your Responsibilities in Cosigning
Before putting your signature on the dotted line of someone else’s loan, review the facts:
- You are considered a borrower: Even though you may have nothing to do with this loan or line of credit after you sign your name, it will appear on your credit report. This means that the primary borrower’s payment habits have the potential to affect your credit score.
- Your credit may take a hit: Besides the question of timeliness of payments, having an extra loan on your credit could affect your credit in another way: by shifting your credit-to-debt ratio. This ratio (which compares your total credit limit to how much debt you have) affects your credit score, which in turn could affect your ability to get future loans.
- You are agreeing to pay: According to figures from the Federal Trade Commission, of cosigned loans that go into default, 75 percent are paid by cosigners. And if the primary borrower decides to file for bankruptcy protection, you’ll likely be required to pay the loan as well.
- You agree to all loan terms: This means that if the primary borrower falls behind or defaults, you’ll be responsible not only for the loan payments but also for any late fees, penalties, increases in the interest rate, and so on. Further, a debt collector could conceivably approach you for payments, and might (in extreme cases) even resort to legal measures.
The Moral: Cosign with Caution
This isn’t meant to detract people from cosigning altogether – in fact, cosigning a loan can be a great way to help a loved one build or rebuild credit. But before you agree to put your signature on lending papers, make sure you understand the potential consequences. You may want to consider:
- Making a separate contract between you & the primary borrower to define expectations;
- Setting up an “emergency plan” for making payments if the primary borrower thinks she might miss a payment;
- Discussing the primary borrower’s income sources and spending habits to get an idea of what you’re working with financially; or
- Setting aside some money specifically for covering that loan.
The bottom line is to treat a loan you’re asked to cosign as you would any other loan – after all, it could have as big an impact on your credit score and financial health.
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