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3 reasons not to co-sign a loan

Co-signing any loan can be disastrous to your credit, finances and future. But if you're going to do it anyway, at least protect yourself.

By Stacy Johnson Apr 24, 2012 6:07PM

This post comes from Angela Colley at partner site Money Talks News.

Money Talks News on MSN MoneyA few years ago, a friend told me he didn't have the credit to get a car loan. Would I co-sign for him? I almost did it, but my father stopped me with some wise advice: "Don't gamble with your credit score for someone else's benefit.”

So I didn't co-sign, but my friend found someone else to do it. Nine months later, he stopped making payments, the lender repossessed the car, and the co-signer's credit was ruined. I narrowly escaped financial disaster.

That's my story, but co-signing a car loan, or any loan, is rarely a good idea for anyone. Stacy Johnson explains why in the video below. Then read on for more reasons why you shouldn't co-sign and tips if you do it anyway. 

Here's a recap of why you should be wary of co-signing. And keep in mind that we're talking about car loans in this post, although the advice applies to any loan.

You're responsible for the loan. By co-signing, you agree to take over the loan if the primary borrower doesn't pay. In 2011, 0.51% of all auto loans were delinquent -- meaning they were at least 60 days late, according to Bankrate. If you had co-signed one of those loans, the lenders would be looking to you for money.

And that could spell financial disaster. Experian's State of the Automotive Finance Marketreport shows that in the fourth quarter of 2011, Americans borrowed an average of $26,419 for new cars and $17,404 for used cars. I know I don't have $26,000 lying around to cover someone else's loan -- or extra money to make that person's payments.

You're risking your credit rating. Your credit rating will tank if your friend's or family member's car is repossessed or the person makes late payments. Repossession appears on your credit report for seven years, starting from the first missed payment, Experian explains. If the lender sends the account to collections -- and it will -- the collection will also show on your credit report for seven years.

Image: Man sat in a convertible (© Image Source/Getty Images)You're risking your borrowing power. Here's how my scenario would have played out if I had agreed to co-sign: At the time, I had a car and a good credit rating. I co-sign my friend's car loan. Nine months later, he defaults on the payments, and the car is repossessed. A year later, I need a new car, so I apply for a loan. The lender sees a repossession and a collection on my credit report. At this point, I imagine the lender doubling over in laughter as he turns me down.

You'll have a hard time qualifying for any loan with a black mark that serious on your credit history. And if you do qualify, you won't get the best (or even good) rates. For example, in the fourth quarter of 2011, the average interest rate on an auto loan was 4.54% for a prime borrower, according to Experian. Nonprime borrowers qualified for 6.34% on average, and subprime borrowers got 9.55% on average.


Not convinced? OK, if you're going to co-sign anyway, at least heed this advice:

Put your name on the title. Stacy said it best:
"If you're co-signing a car loan, make sure your name is on the title as co-owner. You owe, you own."

That will be important: You can take possession of the car should the primary borrower stop making payments. Then you can drive the car or, providing the co-owner agrees to sign over the title, sell it to help pay off the remaining balance.

Ask for a key. You're an owner of the car, so you should also have a key to it. Having a key will make it easier should you ever need to take possession of the car.
Monitor the payments. If you're willing to co-sign a loan, you need to be willing to baby-sit that loan. That means making sure the payments get paid on time every month. Ask for proof. It'll be a hassle, but you'll protect your credit rating -- and your money.

Keep up with insurance. Don't forget the insurance. If your friend totals the car and it's uninsured, he probably won't be able to cover the cost of repairs or replacement himself, and he may not feel like paying off a loan for a car he can no longer use. Guess who that leaves on the hook?

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