It is quite common for someone, who is having trouble getting credit, to approach a friend or relative to act as a guarantor or co-signatory for a loan. They've seen that new car they would dearly love, but have one problem. For one reason or another they are a credit risk, and cannot get a car loan on their own. It may seem simple when they say that all you have to do is sign. That's it! The trouble is, that is only the beginning; at least, if things go wrong, signing for the loan is not "all you have to do."

The Reality Of Co-Signing A Loan - What You Should Know

Before you finally co-sign that loan application, there are a few things you ought to know. In reality, it is not just a matter of signing the loan application. You will be entering a serious loan transaction, in which you will have responsibilities, just as if you were applying for the loan yourself. If your friend does not keep up the repayments on that car, or other, loan, the lender will seek the best way to get the money. Their first port of call? You!

If you are asked to co-sign a loan application, here are a few points for you to take into account. Stop and think about them. Ignoring them could lead you to lose a lot of money yourself, and possibly fall out with your friend.

1. Your Friend Is Probably A High Credit Risk

If someone is asking you to co-sign a loan, that means that the lender is unwilling to take a risk on them on their own. This means that their past credit performance has been so bad that the lender doesnt believe your friend will pay back the loan. Do you want to be the fall guy; the one who carries the risk? You are not a professional lender, and your judgement may be impaired because this is a friend.

2. Impact On Your Credit Report

You have probably worked hard and responsibly to keep your credit report clean. Your friend would benefit from that if you co-sign the loan, but did you know that if your friend becomes delinquent with his payments, it could affect your credit report? All your good work down the drain because of your trying to help a friend.

3. Your Legal Responsibility

By placing your signature in the co-signatory's spot, you will be guaranteeing that if your friend does not make the payments, you will. Do you really have the spare money each month to cover the loan if it came down to that?

4. The Collection Process

If your friend defaults on the loan, and it goes into the collection process, it is possible the lender will bypass your friend and come after you first. After all, they knew he was a risk, and you are the one with the better credit record and more likely to have the money. The law will vary between countries, but in the US this is true in most states, and it would be important to find out where your own state stands on this policy before.

In addition, you should be aware that by co-signing for a loan you may actually reduce the amount of credit you will be able to get yourself. Your friend's loan will count towards your total debt owed.

5. If You Decide To Go Ahead And Co-Sign For A Loan

If you do finally decide to co-sign for a loan, here are a couple of steps that you should take in order to protect yourself as much as possible:

Firstly, it is wise to request that you will be notified in writing, should your friend miss or be late with a payment. By learning of any problems early on, it will help you keep the potential damage to your own credit report from getting out of control.

Next, make sure you also get copies of all the loan documents, plus the repayment schedules. Ask for a copy of everything that your friend gets, in case there is ever a dispute. Then you will know what legal rights you have.

Being a co-signatory for a loan is a serious responsibility, and is something that you should think long and hard about. Even if it is your best friend who is asking you, think seriously about the consequences. It is not just the potential financial loss to you; your friendship could be on the line. Friendship and money often do not go well together, so beware.