Although you would do almost anything to help your friends and family when they need it, you may want to put some boundaries around what that help looks like, especially if you are considering co-signing a loan with them. While it seems like a great way to lend financial support, co-signing a loan can actually have serious financial consequences.
“If your friends or family are in need of financial assistance, there are better ways to lend a hand other than assigning your name to an additional debt, which is what you are doing when you co-sign a loan,” says Jeff Schwartz, executive director, Consolidated Credit Counseling Services of Canada.
“If it’s feasible, you could lend them the money yourself. Or you could lend your friend or family member support by helping them source out other potential financial solutions, like consolidation or debt management programs, depending on the situation.”
Why this option?
When you co-sign a loan, generally one person is agreeing to make the payments, while you- the co-signer are guaranteeing that this will happen. And you are guaranteeing 100 per cent, because if the primary borrower (your friend or family member) defaults on the loan payments, you are completely on the hook.
You have to consider why your friend or family member is asking you to co-sign in the first place. Chances are they didn’t qualify on their own. When people are denied for a loan, it’s usually because they have poor credit history or because they don’t have the income to support the payments. Does either or those apply to your friend or family member?
These are tough questions; however you have to ask them. If, indeed your friend or family member hasn’t handled credit well in the past, what makes you think that this situation will be different?
It’s not 50/50
A common misconception is, as a co-signer, you are splitting the loan obligation. Not so.
Let’s say that your friend or family member can’t make the payments. Then the burden shifts to you to field all of the payments. As a baseline, if you are seriously considering co-signing, you’ve got to assume that you will make payments and determine how comfortably your own budget will support them.
If you are unable to make payments because your friend or family member defaults on a loan, you run the risk of ruining your own credit history. You’re also liable and open yourself up to litigation from the lender when they seek to reclaim the debt. And, once again, this is not a 50/50 split between you and the primary borrower. It’s all on you.
What’s in it for me?
In finance, there is a relationship between risk and reward. However, when you are co-signing a loan, you are taking on all the risk for no reward at all (except maybe the satisfaction of helping your friend or family member in need, but there are other ways to do that).
No matter how you slice it, it’s not equitable.
What if semi-worst case, the primary borrower can’t make their payment and you have to foot the bill? Or extreme worst case, your credit and finances take a serious blow as a result of the loan? That is hard for any relationship to withstand, so if you value the relationship, it’s a good idea to seek out other options. Sometimes a gift of the funds is the best way.
Do you have a friend or family member who is shouldering an unmanageable debt load, and want to help? The first step is to help them determine their options. Call one of our trained credit counsellors or check out our free online debt analysis.