Should you co-sign a loan?

Emily and Jack have been seeing each other for two years, and things are getting serious. One night, over a candlelit dinner at their favorite restaurant, Jack pops the question: “Can you co-sign a loan so I can buy a new truck?”

Six months ago, Jack started a new job as a salesperson on commission, so he can’t yet demonstrate a reliable income. He also has a tendency to buy things on credit, and his cards are almost maxed out. Emily, on the other hand, has a sterling credit score and makes a good salary. Jack was turned down when he applied for his truck loan, but the lender offered to reconsider if Emily agreed to co-sign and assume the responsibility. Should she say yes?

Probably not.

Many people agree to co-sign loans without understanding their obligations. You aren’t simply putting in a good word for someone. You are promising to pay back the loan if the primary borrower is unable to do so. If that primary borrower is your significant other, the loan could cause a strain in your relationship. And if the relationship ends on a sour note, you could face a serious financial crisis, perhaps even bankruptcy.

Co-signing is not co-buying
The type of co-signing arrangement Jack is suggesting in the above example is not the same as what a couple might do when acting as co-buyers. For example, if they were to co-buy a home and take out a mortgage in both their names, it would be secured with a property held jointly by both of them. If the relationship ended, the couple could sell the house, pay off the mortgage and split any money that’s left over. Or they could agree to have one spouse buy the other out. In either case, both would be equal partners in ownership as well as in debt.

What Emily is considering, however, is entirely different, because it’s not an equal relationship. If Emily co-signs for Jack’s truck loan, it does not mean that she owns half the vehicle. Jack will own the truck, but Emily and Jack will be equally responsible for paying off the loan. She assumes all of the risk, but receives none of the reward.

You’re still on the hook if you break up
Think ahead to what would happen if the couple breaks up and Jack stops making payments. The lender will repossess the truck, but there may still be thousands of dollars owing. Since Emily is more likely to have the means to pay -- remember, that’s why Jack needed her to co-sign in the first place -- the lender may go after her first. If she’s unable to come up with the money, her once stellar credit rating will suffer, her wages could be garnished and she might even be sued.

No one who co-signs for a significant other thinks this will happen to them -- it’s hard to imagine that someone you love would leave you on the hook for a huge debt. Time for a reality check: Bankruptcy lawyers and credit counselors regularly find themselves advising people who have been stiffed by ex-partners for whom they co-signed a loan. In fact, when these loans go into default, as many as three out of four co-signers wind up being the ones who pay them off.

Limit your risk if you do co-sign
If you still want to help your significant other borrow money, think about ways to protect yourself. If your partner can get approved for a $10,000 loan but he needs $20,000, you could encourage him to accept the $10,000, and then borrow the rest yourself with an entirely separate loan. That way you’re responsible for only half the total amount borrowed. If you are co-signing a loan to buy a car, you might insist on being the registered owner, even if you never drive the vehicle.

The Federal Trade Commission makes two other recommendations to anyone who co-signs a loan. First, ask the lender to notify you in writing if the primary borrower ever misses a payment so you can nip the problem before it spirals out of control. Second, ask the lender to include a clause that makes you liable only for the outstanding principal if the loan defaults -- late charges or legal costs associated with collecting the money would then not be your responsibility.


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