I mentioned in my last post that cosigning loans is risky. How risky? According to the FTC, depending on the type of the loan, as many as three out of four primary borrowers default on their obligations, leaving the cosigner to pay. This is, after all, why they need a cosigner: they're not good credit risks, either because they have too much debt already, or because they don't pay their bills on time.
(What about someone with no credit history? Contrary to popular belief, you can get a mortgage with a zero credit score--there are credit unions and companies like Churchill Mortgage that do manual underwriting of loans. If you want to help someone establish credit for the first time, give them $500 to get a secured credit card, then encourage them to make modest charges and pay off every month. Problem solved.)
If you think that they really need the money, and that you're not just helping someone dig themselves even deeper into financial irresponsibility, then my advice is to just give them the money.
Give them the money? I can't possibly afford to do that!
Well, my friend, given the default rates of primary borrowers, that is what you're doing when you cosign--with the additional cost of origination fees, interest payments, late fees, collection fees, a black mark on your credit report, and probably, a destroyed relationship.
When the primary borrower defaults, you're on the hook, not just for the loan, but for any late charges or collection fees that may have accrued. If it's a car, the repo man will sell it for cheap at auction, and then sue you for the difference--there are no "non-recourse" auto loans. Meanwhile, your credit will be trashed. Contracts don't always include notice requirements for the secondary borrower, so you may not even find out about late payments until it's in collections.
Even if they pay, the full amount of the outstanding loan will be counted against your debt-to-income ratios for the purposes of both calculating your credit score, and obtaining loans for yourself, since after all, you are responsible for paying it off. That may hamper your ability to get a mortgage or other financing.
If you can't afford to pay off the loan, then--no matter how much you love them, how great your need, or how much you want to believe they will pay--you must "just say no".
Moreover, many people mistakenly believe that cosigning makes them the payor of last resort--that they will be on the hook only after the collections department exhausts every possible effort to make them pay. This is almost the opposite of the truth. You are fully liable for the debt, and while my understanding is that it varies by state, in many places the collectors get to choose who to go after. Who do you think they will choose: the deadbeat with an empty bank account, or you, with your sterling credit and well-padded savings?
I understand that this is very hard advice. Saying "no" to someone who wants you to cosign can be very, very hard. Usually it is a good friend or a loved one, often with big financial troubles.
A few years back, Terri Cullen wrote a very good piece
on making that hard decision for a relative who wanted help getting a consolidation loan. She clearly agonized about the decision, but what she did was absolutely right. Consolidation loans do not have a good track record at helping people get out from under debt (the same is true for rolling high-interest debts into a mortgage or home equity loan.) According to most estimates I've seen, only a minority of people who consolidate debt actually end up paying those debts off; according to one estimate
, after two years 70% up with the same (or more) debt than they started out with.
That doesn't mean you can't give people financial help. You can loan them money, or better yet, give them a little money as seed capital: $1500 to buy a beater to get to work; $500 to put down for a secured credit card to start rebuilding their credit. And you can always help them get their spending under control by working their budget with them.
Often, of course, this type of help will be refused. They don't want a beater, they want a "decent" car that will look good in their driveway. They don't want help budgeting; they want a lower interest rate so they don't have to cut their lifestyle to the bone.
But you're not really helping someone if you assist them to take on a large car loan when they have had historical trouble paying their bills, or to refinance their debt without attacking the spending that brought on the debt in the first place. "Helping" people to avoid dealing with their problems isn't much help at all. It feels terrible to say no, and the person will probably be hurt when you do. It may sour the relationship. But keep in mind that however bad it feels, and however much the relationship suffers, this is nothing compared to the bad feelings and relationship problems that you will encounter if you become their chief creditor.
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is a columnist at Bloomberg View
and a former senior editor at The Atlantic.
Her new book is The Up Side of Down