Cosigning Loans: 3 Risky Situations to Avoid

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Be careful before helping someone out by cosigning a loan -- you could wind up hurting your finances in the process.

There may come a point when someone in your life needs your help getting a loan. Maybe that person is a sibling, child, or long-term friend. And if your credit is great, you're certainly a viable candidate to be a cosigner. But before you agree to take on that role, you must understand the potential repercussions involved.

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What does cosigning a loan mean?

When you cosign a loan, you become legally responsible for paying it back, even if you're not the person who needed that loan in the first place. As long as your name is on the loan agreement, the lender in question can come after you if the primary borrower -- the person you're helping out -- doesn't keep up with his or her payments. At that point, you risk having to pay back money you didn't actually borrow yourself, or having your wages garnished if you can't make those payments. 

Furthermore, if you cosign a loan that the primary borrower falls behind on, you risk damaging your own credit score. That, in turn, could make it far more difficult for you to borrow money yourself when you need to. As such, you really can't cosign a loan for just anyone. Here are three situations where it pays to deny someone's request that you be his or her cosigner. 

1. The borrower is bad with money

If the person asking you to cosign a loan is an adult, then chances are that there's a reason he or she can't qualify to borrow money solo -- that reason being that his or her credit score is atrocious. If you know for a fact that the person asking you to cosign a loan is bad at handling money, or has a history of racking up debt and struggling with it, then you definitely don't want to take the chance of cosigning and potentially having to cover that debt yourself. 

2. The borrower has no experience handling money

Sometimes, the reason that people need help getting loans is not that they've proven themselves to be bad with money, but rather, because they haven't had any experience at all. For example, your child might ask you to cosign a loan for a car, and he or she could be the most responsible borrower you've ever encountered. But because he or she has no credit history and no experience paying back debt, that's not a chance you should be willing to take. The same holds true for an older adult in your life who's never had to manage money independently -- say, a cousin in his or her late 20s who's first moving out of his or her parents' house and taking on independent bills. 

3. You're planning to apply for a loan yourself

When you cosign a loan, the monthly payment associated with it counts as money you're responsible for. And that could prove problematic if you're seeking to borrow money yourself. Whenever you apply for a loan, whether it's a personal loan, mortgage or auto loan, lenders take into account your debt-to-income ratio, which is a measure of how much debt you're responsible for relative to your income. The higher that ratio, the lower your chances of getting approved for a loan -- which is why you shouldn't take the risk if you know you'll be applying for one in the near future. 

Don't be afraid to say no

It's easy to get pressured into cosigning a loan, especially if the person asking is someone important to you. But remember, there's nothing wrong with looking out for your own financial interests, and if becoming a cosigner puts you in an uncomfortable position, you shouldn't hesitate to say no. 

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