I remember back when I was 18 years old. I was convinced I wanted to buy a nice car that required a car loan. The only problem with my idea was that I was 18 and had no credit (and really shouldn’t have been buying a car at the time). Since I knew no reputable bank would give me a loan for a car unless they had really ugly terms, I asked my parents to cosign the loan for me. My parents completely trusted me and my judgement but they did spend quite a bit of time making sure I understood what I was getting myself in to. In the end, I opted not to get a loan for a car.
Looking back, I think my parents did a good job of educating me on the risks of getting a loan but I also think that they did a good job of protecting themselves from taking on a potential payment if I had trouble paying. When you cosign a loan, you aren’t just saying, “Yeah, I’ll vouch for this guy.” What you are doing is actually telling the bank, “I trust this guy so much that I’m willing to “back” him financially if there is ever a problem and he can’t pay”. That’s a lot of trust to have in one person and it’s most definitely not something I’d ever want to do unless it was for a very close family member that really needed the help and I could manage the payment if my family member ever defaulted.
Recently, a friend of mine relayed a story about someone he knows, “Marcia”. Marcia offered to have an exchange student from Indonesia stay with her. I think she did this both for the experience and for the added cash flow to her budget. Marcia received a monthly allowance for hosting the student and it really helped her cover her expenses for the household.
After the student had been living at Marcia’s house for awhile, the student asked Marcia if she would consider cosigning a student loan for her. Marcia said yes and signed the paperwork. Everything went well for a while until the student moved back to Indonesia. It wasn’t long after she left that Marcia received a notice that the loan was about to go in to default unless she paid $1600 to catch it up and then took over the $300 per month payment. Marcia had no choice but to do this in order to protect her own credit. Now she has had to take on the $300 payment which has significantly impacted her budget. She has talked to the student back in Indonesia (Yikes, how much was that phone call) and the student has assured her that she’ll start paying again soon. I hope that Marcia doesn’t hold her breath though because the body can’t live without oxygen for too long. The reality is that the student really doesn’t have a ton of incentive to pay the loan off. She doesn’t care if her credit in the US is impacted and probably doesn’t have the income levels to support paying the loan each month. The only thing that Marcia has going for her is that the student might feel bad for putting her in this position. Needless to say, I bet Marcia might do things differently the next time someone asks for her to cosign a loan.
When considering whether to cosign on a loan for someone, you may want to consider:
- How well do I know this person?
- How has this person handled money in the past?
- Does this person have the income now to support paying the loan back?
- What will this person be doing in the future? (Like living outside this country)
- Can I take on the payment if this person was to default on their loan?
- Will my credit report be impacted by cosigning this loan?
- What are the terms of the loan that I’m cosigning?
The bottom line is that you should review the loan documents and consider the whole situation before deciding whether you’ll cosign a loan for someone. You never know how the other person’s situation might change which could cause you to have to pay back the loan on their behalf.