Should You Ever Cosign on a Loan?
A few years ago, Experian conducted a survey that found that approximately two-thirds of all millennials (those born between the late 1970s and mid-1990s) have used a cosigner at least once, usually a parent.
That’s a lot, but it’s not exactly surprising. Cosigning is so popular because lenders and creditors, in an attempt to reduce their risk, set pretty high bars for borrowers. If you can't clear that bar your only option may be to ask a parent or grandparent to cosign. But that essentially shifts much of the risk to the cosigner, who could potentially find themselves on the hook for loan and credit payments they didn't plan on.
Which begs the question: is it ever a good idea to cosign a loan?
The Reasons for Cosigning
To back up a little, cosigning a loan or application (usually for housing or utilities) means that you’re essentially acting as a guarantor on the transaction – if the borrower or applicant doesn't fulfill the terms of the agreement and make payments as they're due, you’re on the hook. You either have to make the payments yourself or your credit takes a hit, the same as if you'd taken out a loan yourself and neglected to make payments.
The most common reason why anyone would cosign on a loan or credit card or rental application is because the actual borrower isn’t a strong enough candidate on their own. They may have poor credit. Their income may not be sufficient. There can be any number of reasons. The cosigner is using their good name (and good credit, most often) to back-up the transaction. That’s why the majority of cosigners are parents. They can use their credit history and established incomes to help their children receive better loan terms or find better housing options.
As lenders have moved to reduce their risk (especially in the fallout of the Great Recession of 2008) they’ve tightened their standards for lending. If young adults haven’t already been working on building their credit history they may find themselves facing an uphill climb. In fact, according the Experian survey, the two most common reasons millennials seek cosigners are for student loans (35 percent) and for residential leases (32 percent).
Therefore, it’s pretty understandable why parents jump into the breach to help their children. If they feel they can leverage their credit history to help their children obtain student loans and an apartment in a preferred neighborhood, they’ll do it – even if it’s not in their own best interests.
The Arguments Against Cosigning
A 2016 CreditCards.com survey found that 38% of cosigners ended up having to pay some or all of the loan or credit card bill; 28% saw their credit score drop because the person they cosigned for missed payments; and 26% percent said the cosigning experience damaged the relationship with the person they were trying to help by cosigning in the first place.
That's why, in general, most experts say just don’t do it when it comes to cosigning. It can cost you money, it can hurt your credit, it can strain your relationships, and it can even get you sued. In fact, lenders are more likely to sue the cosigner to recover a defaulted loan. Why? Because the cosigner is equally responsible and – by virtue of being the cosigner – they’re much more likely to have the financial assets available to repay the defaulted loan.
Basically, cosigning means becoming directly impacted by a loan or agreement that you don’t directly control, and that can be a very bad gamble to make.
So, Should You Ever Cosign a Loan?
While it's easy to say never cosign a loan, that's a pretty hard line to take, especially when it comes to the happiness, comfort, and success of your children or grandchildren.
The solution might be something in between. Avoid cosigning whenever possible. Look for alternate solutions. If cosigning is the difference between a great apartment and a pretty good apartment, then pretty good needs to be good enough. If it’s the difference between any apartment and no apartment at all, then consider cosigning with the condition that you maintain an open dialogue about finances to help ensure that the renter never falls behind.
Cosigning should be left as a last resort, but it can be an acceptable option if both parties are willing to be open and honest about money. If you trust your children enough to cosign on a loan, then they need to trust you enough to let you know that they’re struggling to make payments and why that is. Make money a safe topic of discussion from an early age and you’re less likely to run into the kind of unpleasant surprises that cosigning can lead to.
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Article updated September 2020