You want to teach your teenager fiscal responsibility and are not willing simply to buy that special first car without some commitment. By buying his or her own car, your child can establish a good repayment history and be well on their way to a superior credit score. However, if lenders are unwilling to loan money to your child because of a lack of credit history, you may have to assist by co-signing the loan — but be aware of the responsibilities that you take on by doing so.
When you co-sign a loan, you are not merely attesting to the main borrower's capability to repay, you are also assuming responsibility for paying back the loan just as if you had taken it out on your own. You will be expected to attend the loan closing and sign all the necessary documents to assume responsibility. Furthermore, in most cases, you cannot remove yourself as a co-signer. You can ask the lender to write into the contract that your name be removed after a certain amount of timely payments, but they are not likely to oblige.
If the primary borrower stops making scheduled monthly payments, you become responsible for making those payments. As a co-signer, you should ask for monthly statements to be sent to you in order to verify that the primary borrower is making regular payments as expected. Check the statements to verify that the correct payment amount is being made on time in order to avoid late fees at best and default at worst.
Should he or she default on the loan, you are responsible for paying the balance to the lender; generally, the lender has the right to repossess and/or sue you to recover the balance. The lender may sue the primary borrower as well, but it is more likely that the lender will target you, the one with (presumably) more money and assets. State laws vary on co-signer lawsuits and repossession; consult your state Attorney General's office for details.
If the lender's suit against you is successful, other assets and income could be endangered. You could suffer wage garnishment or have a lien placed on your home. Settling the lawsuit can have difficult side effects as well — you will have to pay taxes on the forgiven portion of debt as if you received it as income.
The effect on your credit is also the same as if you had taken out the loan on your own. Missed or late payments and loan defaults will have a detrimental effect on your credit score. You can check your credit score and read your credit report for free within minutes using Credit Manager by MoneyTips.
Any loan that you co-sign also appears as your personal debt on your credit report, raising your debt-to-income (DTI) ratio. Since this ratio accounts for 30% of your FICO credit score, expect your credit score to drop via a higher DTI. If you intend to apply for a new credit card or a mortgage soon, the increased DTI can cost you significant money through a higher interest rate — or result in outright denial. That is true even with no missed payments or other missteps by the primary borrower.
The same co-signing responsibilities are shared regardless of your relationship to the co-signer and their credit history. If you are co-signing for someone with a bad credit history instead of a lack of one, keep in mind the added risks involved.
There is realistically no good financial reason to co-sign a loan; the only good reasons are personal in nature. You have to decide whether the personal rewards of helping someone out are worth the individual financial risks. If they are, do so — but get a copy of the statements and keep close track on payments. Treat the loan as if it were your own, because it may turn out to be your loan in the end.
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