Use Caution When Co-Signing Loan

Q: A friend asked me to co-sign a student loan for her. She will start paying off her student loan after she graduates from school. I am planning to purchase a bigger house next year.
 

What does it mean to “co-sign” a loan? What will I be responsible for? And, how will it affect me in the future in terms of my credit and qualifying me for a mortgage?

I have good credit now, but please help me because I’m not savvy at all on this topic.

A: I'm glad you asked these questions now, before you signed the documents for your friend, rather than after.

When you co-sign a student loan, auto loan, or mortgage, you become entirely responsible for this debt if your co-borrower (in this case, it’s your friend) stops making her loan payments for any reason. That means, if she suddenly stops making payments, your credit will suffer even if no one told you she has gone delinquent on the loan. If she’s 60 days late in making a payment, your credit history may indicate that you’re 60 days late on this loan.

In addition, because you are a co-borrower, the lender will look to you for full restitution and you'll be on the hook legally for every last dollar due on these loans.

How will this affect your ability to borrow other money? In short, it will reduce the amount which you can qualify to borrow.

When you get approved for a mortgage, a conventional lender will allow you to spend up to 28 percent of your gross monthly income on your mortgage, property taxes and insurance. You can spend 36 percent on your total debt service. That means if your friend's monthly school loan payments will be $250 per month, a lender may subtract $250 per month from the total amount you have to pay off your debt simply because you've co-signed for this loan.

There are lenders who will not ding you quite in the same way. For example, instead of lowering the total amount of your loan, you may have to pay more in fees or accept a higher interest rate on your mortgage.

While I'm sure you like your friend, the person who should be cosigning this loan are her parents or another relative. Your smartest move is to focus on your own financial future. Co-signing loans can be a risky business and quite damaging to your ability to get your own loan and maintain your own good credit history.

I have quite a bit of additional information on cosigning mortgages on my website, ThinkGlink.com. You might check there for additional details.

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