Mike was a recent college grad. He found himself a good job, but was having issues with the vehicle he had driven since he was 16. It was time for Mike to get a new car. He went ahead and found a car he liked at a local dealership, but when he went through financing he got stuck with a 12% rate! Why so high? Mike didn’t have any credit. He had to get his mother to cosign a car loan with him in order to bring down the interest rate.
The new interest rate Mike was able to get for his loan was now 3%. This would lead to thousands of dollars in savings over the life of the loan, all because his mother, who had a credit history, signed it with him. Did Mike’s mom do the right thing? Probably yes, she trusts her son and knows he just got a good job, but many people cosign a loan not thinking about any of the consequences. Below are 3 reason why you should not cosign a loan.
WHY YOU SHOULD NOT COSIGN A LOAN REASON #1
You are responsible for the loan if the person you cosign with cannot make payments. In Mike’s situation above, his mother knew that signing a loan with her son would save him thousands of dollars, but if Mike suddenly lost his job or forgot to make payments, then his mom becomes the responsible party. Never cosign a loan with someone you don’t think can make the payments.
WHY YOU SHOULD NOT COSIGN A LOAN REASON #2
Your credit score can be affected, both positively and negatively. An institution loaning you the money can offer a lower interest rate with a cosigner because they have mitigated the risk of default for the loan. If you cosign a loan and the loan is repaid in full, you can see your credit score rise, but if the loan goes into default, it can hurt your score and lower your chances of getting future financing.
WHY YOU SHOULD NOT COSIGN A LOAN REASON #3
Once you add your name to a loan you cannot take it off. If you and a friend cosign for a loan together, then you better hope that friendship doesn’t go south anytime during the loan. Relationships sometimes fizzle and don’t work out. It is best to make sure that emotions don’t get the best of you when cosigning for a loan.
Cosigning a loan can be a good way for someone to build credit. It is also important to remember that you are taking a risk on building someone else’s credit for the sake of your own credit. Sometimes people can make financial decisions based on emotions, cosigning a loan is a perfect example of a financial decision that should not be made on an emotional level.
Budget Smart, Invest Wise
James Hendrickson is an internet entrepreneur, blogging junky, hunter and personal finance geek. When he’s not lurking in coffee shops in Portland, Oregon, you’ll find him in the Pacific Northwest’s great outdoors. James has a masters degree in Sociology from the University of Maryland at College Park and a Bachelors degree on Sociology from Earlham College. He loves individual stocks, bonds and precious metals.