Co-signing a loan is like bad credit waiting to happen

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loans to friends a bad ideaA friend recently came to me about a loan she had co-signed for her roommate to pay for culinary school. The roommate completed the program and got a job, but she wasn't making enough money to pay off the loan. She deferred the loan as long as possible, and with each deferral, the loan balance kept growing and the interest rate kept increasing.

Then the roommate met a boyfriend and moved out. The boyfriend didn't like my friend and talked her ex-roommate into forgetting about the loan. So she stopped making any payments on the student loan and left my friend with the bill. My friend wanted to know what she could do because she wanted to buy a house and she was pretty sure this would destroy any chance of her getting a loan. But if she made the payments on the student loan, then she wouldn't be able to afford the house. Ah, what to do, what to do?
I told her she didn't have any options unless she wanted to take her ex-roommate to court, which she didn't. Even with a successful judgment, unless the person who owes the debt has assets that can be attached or income that can be garnished, there's little chance of collecting. Plus, legal fees and court costs can add up quickly.

As a co-signer, she had taken responsibility for the loan and she had to make the payments or the lender could start collections. As a result of her decision to help out a friend in need, she was forced to give up her plans to purchase a home and she got stuck with a student loan for schooling she never even got. Even if she were decide to file for bankruptcy -- another option -- the student loan couldn't be wiped out.

Unfortunately, I hear this story all too often from people thinking they're helping out a friend or relative and, instead, end up with a mound of debt and an often destroyed credit history. There's one simple rule you should always remember: Don't co-sign on a loan or agree to take out a loan for someone else who isn't able to qualify for that loan on their own. Often the reason they can't get the loan on their own is that they've already got a low credit score because they haven't been paying their bills.

There's one exception to that rule. If you're a parent and you want to help your child, then do it. Your child may need a co-signer for a school loan or to get their first credit card or for a car loan. In this case, you might want to consider it but only if you believe your child is responsible and will pay back the debt. Before you decide to proceed, be sure your child has both the emotional and financial stability to make the payments. But be ready to make the payments if he or she doesn't, or your credit will be ruined.

The bottom line is, when you co-sign on a loan, you promise to make the payments if the person taking out the loan doesn't. As a co-signer, you:

  • Obligate yourself to loan payments if the borrower defaults.
  • May be denied a loan on something you want to buy because you've got outstanding debt as a co-signer.
  • Live with the uncertainty that you'll be stuck with the debt..

By helping out a friend or relative, you can sometimes make things worse for yourself by being unable to do the things you want to do. In this case, my friend had to put off buying a house because she had co-signed the student loan.

It's kind hearted of you to want to help out your friends or relatives, but don't put your good credit rating at risk in the process. Unless you know you can make the payments if the person you're trying to help doesn't pay the money back, don't co-sign on a loan.

Lita Epstein has written more than 25 books including the Complete Idiot's Guide to Improving Your Credit Score and The Complete Idiot's Guide Personal Bankruptcy.

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