Co-signing a loan is not the best way to keep your financial health in good condition. It is actually a dangerous transaction. You are putting your finances on the line just because someone else was irresponsible enough to let their own financial position be compromised.
But how does one become a co-signer? This is when you take on the responsibility for someone else’s debt. According to the explanation from FHA.com, this is different from a co-borrower. When you co-sign, you just take it upon yourself to be equally responsible for the debt that someone else will benefit from. When you are a co-borrower, you also have a need for the debt being borrowed. It is okay to be responsible for the debt because you will also benefit from it. A co-signer has the same responsibilities but does not have the same interest in the debt.
See the difference? Clearly, a co-signer is severely at a disadvantage.
But why would you want to co-sign in the first place? In most cases, people co-sign because they feel financially responsible for someone else. This usually happens between parents and children. Sometimes, parents help out their kids by co-signing loans – usually to help with their student loans. But it can also be the other way around. There are instances when the young adults feel compelled to financially help their parents.
While helping is a good thing, co-signing may not be the best way to do it. There are a lot of things that you need to know before co-signing loans and its effect on your financial health is one of them.
Why is co-signing a loan bad for your finances?
Statistics reveal how bad co-signing can be to your finances. According to the data from WashingtonPost.com, 28% saw their credit scores drop because the primary borrower submitted late payments or did not pay anything at all. 38% of the co-signers were also forced to pay a part or the full amount of the loan because the other person was not responsible for the debt.
These data reveal that co-signing can compromise your financial health. It seems unfair on your part – especially if you had been working hard to be responsible for your debt.
Here are 5 reasons why you should think twice before co-signing a loan for someone else.
It does nothing to help your finances. As discussed, being a co-signer is not like being a co-borrower because you have no vested interest in the loan. It is not borrowed to help you. However, you still have to shoulder the responsibility of paying it back. Other than trying to help the primary borrower get approval for the loan, this will not directly do your finances any good – so why bother?
It makes you responsible for a debt you will not benefit from. The main danger in co-signing loans is being forced to pay the debt because the primary borrower failed to meet the payments. This is the reason why it can be a danger to your financial health. You may have financial goals and expenses to meet. But since you signed for that loan, you will be responsible for paying it back. The lender will go after you and they have every legal right to do so.
It compromises your credit history. Your financial health will be ruined if the primary borrower keeps their financial troubles a secret from you. Sometimes, co-signers are surprised to see their credit scores decrease significantly because the other person did not say that they failed to pay the loan. When you find out, it is usually too late already and your credit history is already ruined. According to CreditSesame.com, a ruined credit history is one of the ways that can compromise your ability to get a mortgage. Do not let someone else keep you from your financial goals.
It may have tax implications. There are some co-signed debts that you can arrange to settle so a portion of it will be forgiven. You have to know that the forgiven amount will be considered taxable income. That means you have to pay taxes for it. Both you and the primary borrower will be expected to pay it off. If the latter fails to pay it, then the burden will go to you.
It can ruin relationships. Finally, and probably the most important reason why you should not co-sign a loan is the fact that it can ruin your relationships. Money has a way of coming between people. Of course, if the primary borrower did not tell you that they are not paying the loan and your credit score suffered, that will make you feel bad. This will create tension between you. Chances are, it will also involve other members of the family as they will take sides between the two of you.
Even financial experts feel strongly about co-signing loans. Here is a video from the Suzy Orman show where the famous financial guru talks about her views about co-signing loans.
As you can see, she is strongly against this financial transaction. She believes that it is not really helping anyone – even the one you are trying to assist.
How can you protect your financial position and still help?
If co-signing is out of the question, how can you help a struggling loved one without compromising your financial health? Here are a couple of suggestions.
- Identify why they cannot get a loan on their own. Start by understanding why they were denied credit. In the case of parents co-signing for their student loans, it is understandable that the students have a thin credit history. Sometimes, it is because of irresponsible credit choices. Regardless of the reason, you need to know about this so you can help them solve the issue that is keeping them from borrowing on their own.
- Give as much cash as you can afford to lose. Do not expect to get paid. A cash gift will help them more than co-signing a loan. But only give what you can. Sometimes, those who are looking for a co-signer only wants financial help. If you can afford to give a cash gift, then they might not have to borrow money anymore. Of course, you want to think about the first suggestion. Do not blindly give financial aid. Make sure the person you are helping will also help themselves.
- Help them research options and guide them in paying it back. If the primary borrower cannot get a loan because of a bad credit, there are other options they can look into. And if they do get a loan, help them come up with a payment plan. If they can pay this loan back properly, it can increase their credit score and make them eligible to get a loan on their own.
Taking care of your financial health is one thing and helping another with their finances is also a great deed. More than helping other people by giving them money, you should help them stand on their own two feet.
Common questions about financial health
Question: What does financial health mean?
Answer: Financial health refers to your current financial position. It is the state of your personal finances.
Question: What is my financial health?
Answer: This will depend on your current financial position. Check your savings, debt and your financial goals. If you have investments, you can include that too.
Question: Why is financial health important?
Answer: This is important because it gives you an idea about the state of your finances. If you have a bad financial health, it hints that you should take care of your financial transactions.
Question: How do I measure financial health?
Answer: There are a couple of factors that can affect your financial health. To determine your financial standing, you need to look at your savings, debt, and your financial goals. If you have adequate savings, manageable debt and you are on track when it comes to financial goals, then you have a healthy financial situation.
Question: How can I improve my financial health?
Answer: The idea is to increase your financial net worth. The more you are in the positive, the better it will be for your financial health.
