Co-signing a loan for a close friend or family member is undoubtedly an incredibly generous thing to do. However, while you may feel your loved one is totally capable of managing the loan, it’s vital to understand your role and responsibilities as a co-signer before jumping into an agreement. With that in mind, here are four things you’re going to want to consider before co-signing a loan.
1. Know the Risks
Your participation in a co-signed loan doesn’t end at your signature. Responsibility for the loan is shared equally between signers and that means even though you’re not the recipient of the loan, you are responsible for paying it back in the event that the borrower can’t. Additionally, should the borrower make late payments, that negative activity will show up on your credit report, too. When it comes to finances, knowledge truly is power, so it’s important to fully understand what you’re getting yourself into.
2. Know the Terms
In addition to knowing the general risks of co-signing a loan, it’s important to understand the loan’s specific terms and conditions, including: the total amount of the loan, interest rate, due date, length of the loan, whether or not there’s a grace period for payments. Knowing these details can help you better determine whether or not you think the borrower can handle the loan and, in the event they cannot, if you can take on the payments yourself.
3. Know What You Can Negotiate
While co-signing a loan comes with a lot of risks and responsibilities, it is possible to negotiate specific terms of your obligation to help ease the burden. For example, you can ask the lender to agree in writing that it will notify you in the event the borrower misses a loan payment. This can help you to mitigate any payment problems before they get too out of hand. You could also ask to limit your responsibility of the loan to the principal, thus avoiding late payment charges and other penalty fees. While it’s not always a sure thing, it never hurts to ask.
4. Know Your Exit Strategy
Hope for the best, but plan for the worst. Before putting your name on the dotted line, have a plan in the event of a lending disaster. Setting aside money to cover the loan in the event the borrower cannot make payments can help you keep your credit score from taking a hit. It’s also important to know whether or not there will be an option to remove yourself from the loan. Note that while some loans do allow you to do this, it’s typically a lengthy process and is not likely to happen unless you the loan has already been out for sometime.
When it comes to financial decisions, knowledge really is power. While co-signing a loan might significantly help your loved one, make sure that your kindness won’t be putting yourself at risk. Take your time when hashing out the details, do your homework, and make sure there is a lot of communication between yourself, the borrower and the creditor.
If you do co-sign the loan, keep a close eye on your credit reports and credit scores to watch for changes that could signify a missed payment or other issues. You can get your credit reports for free every year at AnnualCreditReport.com, and you can get a free credit report summary updated every month on Credit.com.
The last thing you want is an act of charity leading you into financial hardship.
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This article originally appeared on Credit.com.
This article by Leslie Tayne was distributed by the Personal Finance Syndication Network.