This morning, I am here to tell you never to co-sign for a loan.  There are no exceptions.  None. Nada. Zero. Zilch. Null. Nil. Zilde.

Co-sign

Co-signing for a loan looks like a free way to get a loved one credit, but it is not free. Consider two articles I ran across yesterday:

Being a co-signer is one of the weakest economic positions imaginable. You get no benefit from the loan that is made, but you are liable for full repayment of the loan should the primary debtor refuse to pay. You also have no recourse against the primary debtor.

If you think the one you love is deserving of credit, loan it to them yourself, with a formal loan agreement that allows you to require repayment, or seize collateral.  At least you have some protections here.

What’s that, you say?  You would never take them to court?  Well, then understand, whether you lend or co-sign, you are exposing yourself to loss.  Perhaps it would be better to say to the one you love: “I’m sorry, honey, but lending money destroys relationships. Loan agreements are adversarial by nature.  I want to always be your friend, so I can’t lend you money.”  The same applies to co-signing.

What’s that, you say?  You can’t afford to loan the money, and so must co-sign?  Garbage.  Go borrow the money yourself, and then lend it to them.  You will be better protected than if you co-signed, even if it makes the loan costs explicit to you.

And, if you can’t easily get a loan, why are you letting someone else, however beloved, endanger your well-being?  Don’t be sentimental/dumb.  If you are that hard pressed, tell your beloved the tough truth — “I’m sorry, honey, but we don’t have the resources for it, wish it were otherwise.”

Student Loans

I write this for one more reason. Student Loans are not dischargeable in bankruptcy, unless one can prove hardship, and that is difficult to prove.  If parents have the resources, it is better to lend to your children directly than take out student loans, with their onerous interest rates and payment obligations. You might also then encourage your young adult to be frugal/wise in choices including the school attended, “because we are in this together.”

This method has the virtues of avoiding the hooks of the student loan programs, and reducing total costs where possible. The Federal (not private) student loan programs have one “virtue” — income-based repayment, which varies program-to-program. Attractive if a student thinks he isn’t going to make a lot of money, not so attractive if he thinks he will make a lot of money.  But, at least it gives a better chance of staying out of bankruptcy court.

Conclusion

There are difficulties that come when love and money mix in a bad way.  If you can’t get it done with reasonable protections for you as the lender, don’t make the loan.

And, don’t co-sign, ever.  As we say in investing,”Hope is not a strategy.”  In the same way, don’t co-sign, hoping that everything will turn out okay.  The downside is considerable if it does not because there is nothing you can do to get the one you co-signed for to repay or make amends another way. And it will affect your finances, credit rating, and most of all, your respect and love for the one you tried to help.

Don’t co-sign, ever.

By David Merkel, CFA of alephblog