LOUISE FAIRSAVE: Co-signing a loan
THIS ARTICLE DISCUSSES the scenario for consideration in this series of presentations on using debt wisely: Is the statement – ‘Co-signing a loan that is eventually fully repaid will not affect the co-signer’s credit rating’, true or false?
It is false. When you co-sign a loan you are typically assisting the main borrower who does not have adequate credit history or an adequate credit score. The addition of your credit profile in support of the loan allows the main borrower to secure a loan that would otherwise not have been approved. How that loan is repaid affects your credit profile.
In co-signing a loan, you enter into a legally binding agreement that you will accept the full contractual obligations of the original borrower. Once committed as a co-signer, it is virtually impossible to be removed from the responsibility undertaken; not even divorce may release a co-signed agreement between former wedded partners. Co-signing a loan is a serious undertaking which should only be considered after independent legal advice.
A typical situation would be where a parent co-signs a loan for a son to secure a loan for his first vehicle. The parent becomes equally liable for the debt, and how the son repays that loan will affect the parent’s credit profile. The perfect circumstance would be that the son is reliable and never misses a payment or never makes a late payment. In fact, if the son repays the loan earlier than expected, that would be even better.
On the contrary, where the son misses a payment or makes late payments, for whatever reason, that adverse behaviour will appear as part of the parent’s credit report. Even the outstanding loan itself is recorded as part of the parent’s outstanding credit which can reduce the parent’s ability to borrow further.
Where the co-signer ends up with negative changes in credit profile due to the payment behaviour of the main borrower, family or friendly relations can become strained. On the other hand, positive handling of a co-signed loan has led to deep, trusting and lasting relationships between family members and friends.
When you co-sign a loan, you are handing the main borrower your credit profile which is implicitly better than theirs. It is therefore not unreasonable for you to press for details of plans for repaying the loan from the main borrower. The risk of adversely affecting your credit profile as a co-signer rises as the period for repayment is extended over years. The financial circumstances of all parties to the loan may change adversely; the main borrower may even die unexpectedly, leaving no apparent means of settling the debt.
Yet, co-signing a loan can also be used to build the credit profile of the co-signer. For example, a smart husband allowed his wife to co-sign on loan he made and repaid reliably in order to build and enhance his wife’s credit profile. This identifies a means by which someone with a good to excellent credit rating can assist another to establish and improve their credit profile.
Thus, co-signing need not be ruled out entirely. Persons who undertake to do so for others may further protect themselves by requiring the lender to provide regular loan statements as well as early signals of any problems in repaying the loan. In addition, where the lender may allow it, the co-signer can specifically ask that their liability be limited to the original principal balance.
Co-signing a loan can have a good or disappointing outcome. It is left to your judgement of the character and financial integrity of the borrower, your exposure to personal financial loss and the risk of a tarnished relationship with the main borrower in deciding how to proceed or not with such a legally binding agreement.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. Email: Louisefairsave @nationnews.com
This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.