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Saturday, July 4, 2009

Becoming a Loan Cosigner

When someone applies for a loan with a financial institution, they are subject to a credit check. If they have a poor credit record or don't have a sufficient credit history, their loan application may be denied. In this situation, they may turn to a friend or family member to cosign the loan for them.

A cosigner basically submits his or her own credit record for review along with that of the applicant. If the loan is approved, the cosigner becomes responsible for paying back the loan if the applicant defaults.

Needless to say, becoming a cosigner requires serious consideration because it puts your credit record and financial health at risk should the loan not be paid back. While it might be nice to help out a friend or family member, deciding to cosign should primarily be a business decision. Try to leave emotions out of it. Your main concern is whether the borrower will be able to pay back the loan.

First, be aware that the loan is going to show up on your credit report. This could affect your ability to be approved for your own loan later since the loan you co-signed for may be used to calculate your debt-to-income ratio. It can also affect the interest rate at which you can receive future loans.

If you decide to become a cosigner, do so with the understanding that the borrower will attempt to refinance the loan without you after a certain number of on-time payments. The more money you cosign for, the longer you can expect to be a part of that loan.

Since your credit rating is at risk, it's important to have the loan set up so that you can access the account information. This will allow you to make sure that the loan is current as often as you want. Make sure the lender will inform you of any late payments or non-payments as soon as they happen. All too often, cosigners aren't aware that there's a problem with the loan until it has already affected their credit.

Cosigning a loan for a friend or family member can also put your relationship at risk. Nothing can sour a relationship faster than money issues. It's important for a cosigner to consider the circumstances under which the borrower needs a loan in the first place. If it's due to money management issues or credit card abuse, you aren't going to do them or yourself any favors by cosigning. However, if it's because they're just starting out or it's due to a life-changing event, you may want to consider becoming their cosigner.

To minimize your risk as a cosigner, don't make a habit of it. Others may ask, but you should be firm and tell them you've got your own financial health to worry about. If you do find yourself facing another request down the road, consider it on its own merits. Don't be swayed by your experience with the previous one. If you think your credit record and financial health will face unacceptable damage if the borrower doesn't repay the loan, don't cosign for it. While it may be very difficult to say no, it's not as difficult as repairing your credit from someone else's damage.

If you do cosign, ask the borrower to provide you with regular proof that the payments are being made on time. To further reduce your risk as a cosigner, insist that the borrower purchase personal loan insurance. Such insurance can cover loan payments for a certain amount of time due to unemployment, illness, or death.

Cosigning a loan for someone is much more than just signing your name. You're putting your good credit and financial health on the line for the borrower. It's very important that you carefully review the borrower's need for the money as well as his or her spending habits. If there are too many other debts or they're trying to live beyond their means, just say no.

There are times when being a cosigner for a friend or family member is the right thing to do. Only you can make that decision. If you decide to go through with it, make sure you can afford the cost of any missed payments and that the lender is going to keep you informed of the payment status of the loan.


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