Sara Routhier, Managing Editor and Outreach Director, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming world o...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Feb 19, 2013

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To sign or not to sign?

That is the question facing many consumers. The elusive co-signing role is one that responsible borrowers should avoid at all costs.

Every day, consumers with stable credit histories decide to assist their friends and family members and co-sign a loan, such as personal loans, student loans, or auto loans.

But co-signing is about much more than simply adding one’s name to an agreement. That signature brings with it five major threats for a co-signing consumer.

If after reading these reasons you would rather pass on co-signing a loan, encourage your family members to try applying for a personal loan themselves using this free online application.

Reason 1: More Risk, Less Reward

Co-signing a loan is almost the same as applying for the loan by oneself. The only difference is that a co-signer does not benefit from the risk.

However illogical it seems to a disgruntled co-signer, he or she is just as responsible to repay a co-signed loan in its entirety as the primary borrower is. The inherent reason for an additional signer is to add extra security and precaution for the lender. If a person was linked to the loan, but did not have to repay the loan themselves, it would not assist the lender.

Gail Cunningham, vice president of membership and public relations at the National Foundation for Credit Counseling (NFCC), said that co-signers should prepare from the very beginning to repay the loan themselves.

“Never co-sign on a loan that you are not prepared to repay in full,” Cunningham told loans.org.

A borrower and a co-signer will be punished equally for their failure to repay a loan. For the primary borrower (who likely already has a poor credit score), this will probably not impact their daily life as much as it will impact the co-signer’s.

If the primary borrower applies for other forms of credit, their low score will likely continue to get their applications rejected. But for a safe borrower with a good credit score, being refused on a personal loan application is an experience they are less accustomed to.

Some consumers decide to co-sign a debt because they want to add positive history to their credit score, but that can backfire. After all, most co-signers do not need help with their credit.

Since they were approved as a co-signer, their history is likely high enough for approval on most future borrowing. As a result, the possible “benefit” of achieving a higher score is minimal at best, especially when that benefit is placed side-by-side with the possible consequences.

“Co-signing is taking on new credit, thus could negatively impact the credit utilization ratio of the co-signer,” Cunningham said. “Co-signing could potentially use up available credit that the co-signer might need for himself.”

Reason 2: Inhibits Future Borrowing

Co-signing a new loan can inhibit a co-signer’s future borrowing abilities.

When lenders decide whether or not to approve an application, they look at a borrower’s debt-to-income ratio, in addition to their credit score. If a co-signer puts their name on several loans, their debt liability will likely overwhelm their potential to repay the loans if they go into default.

Being a co-signer on one or more loans can prohibit one’s own ability to apply for their own loans because they become a higher risk in the eyes of a lender.

In addition, applying for or co-signing on new credit puts an additional inquiry into a person’s credit report, which temporarily lowers their credit score.

Credit is not limitless. Borrowers and co-signers need to think about future purchases in order to make a logical decision about co-signing. Many lenders will view multiple open loans on a credit report as too risky, especially if the person’s income level is moderate at best.

Reason 3: Added Legal Worries

If the primary borrower defaults on a co-signed loan, some lenders may sue for the remaining balance and damages.

Lenders will go after the consumer with the highest likelihood to repay the debt. In some situations, the borrower is not contacted in the beginning, and the lender sues the co-signer from the start.

For the two people involved in the loan agreement, the person with the highest credit history will likely be sued first, and this is almost always the co-signer.

Reason 4: Destroyed relationships

Money issues are one of the most common reasons for family disagreements.

Mackey McNeill, CPA and financial planner, told loans.org of a story where family relationships were threatened because of a loan.

One of McNeill’s clients co-signed a student loan for her niece. The loan defaulted at a difficult time, right after the co-signer moved into a new home and lost her job.

The only saving grace for the co-signer was her previously saved assets. She used about 25 percent of her non-retirement assets and savings to pay off the debt, even though she needed to use the money to keep her afloat during her period of unemployment.

Without these, McNeill said she would have taken a serious hit on her credit report.

The niece never repaid her debts. Adding further insult, McNeill said the niece could have done more to keep the loan from default.

“Most young folks have little financial education and they believe if they just graduate, they will be able to repay the loan,” McNeill said.

The burdens that student loans, personal loans, and auto loans place on family members are difficult to overcome for most.

“Collecting old debts from a family member is challenging at best and a situation most of us want to avoid,” McNeill said. “Just because you always paid your debts, doesn’t mean other people do.”

Reason 5: Lack of Control

Co-signing a personal loan is a bad idea because it takes away the co-signer’s control. Co-signers are not the primary contact for the debt they’re linked to, unlike how they would be with a normal bill.  Report updates will be sent to the main borrower first, and it is up to the co-signer themselves to ensure that the primary borrower is repaying the debt on time.

Co-signers can request payment reports and status updates, but since the loan is for another person, it is up to the actual borrower and the lending company to decide if the reports will be distributed to the co-signer as well.

The co-signer needs to review yet another bill each month, further weighing down their financial responsibilities.

Although it might cause hurt feelings in the short-term, co-signers should be just as critical of their friends and family members’ credit history as a bank is when deciding whether or not to proceed with jointly signing a contract. If consumers eliminated their feelings from the equation, almost all would see that co-signing a loan is never a good idea.