Co-signers must do their due diligence on the borrower, probing to find out why they can’t qualify for the loan on their own.Bluestocking/Getty Images/iStockphoto
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When a close family member or friend asks you to co-sign a loan, whether it feels like an honour or a burden, it’s important to treat the request like the business transaction it is, some experts say.
“I look at saying ‘yes’ on a co-signing of an agreement the same way I would look at making a private equity investment,” says Gillian Stovel Rivers, senior wealth advisor and branch owner with Surround Wealth Advisors at Assante Financial Management Ltd. in Burlington, Ont.
“There’s no way to get out of this easily. You have to accept that whatever money you’re handing over may never come back to you. And yet, at the same time, you have to have a good enough feeling about the business case.”
Ms. Stovel Rivers emphasizes that co-signers must do their due diligence on the borrower, probing to find out why they can’t qualify for the loan on their own.
Potential co-signers should also ask what the loan is for. An unsecured liability, with no asset tied to it, such as a loan to pay off credit card debt, has a different risk profile than a loan that’s attached to an asset, such as a car loan.
In addition, Ms. Stovel Rivers says it’s critical to inquire about the payment terms, including the frequency and duration of payments and the interest rate, and to make sure the borrower is comfortable reporting on the loan’s status regularly.
“It’s really important that you see this not just as the offering up of your signature,” she says. “You’re doing it because you’re willing to put in the time and effort and the ongoing transparent communication … to be a mentor to that person and to help them learn to get to a place where they don’t need a co-signer.”
Risks to relationships and finances
From Ms. Stovel Rivers’ perspective, the biggest risk when co-signing a loan is the relationship. She says it’s important to get granular with the details, even when it doesn’t feel comfortable, and to agree upfront on how you’ll disagree later.
The value of being a hero at the moment, coming to the rescue with that all-important signature, may not outweigh the potential cost to the relationship, she warns.
Of course, co-signing is also a financial risk. A co-signer is responsible for the debt if the borrower defaults and his or her credit rating (and ability to borrow in the future) can be affected negatively if the borrower misses a payment, points out Carissa Lucreziano, vice-president of financial and investment advice at Canadian Imperial Bank of Commerce in Toronto.
In addition, it isn’t a given that the co-signer will be informed of missed payments. A co-signer should either check in regularly with the borrower or, even better, arrange with the lender for access to loan statements.
“Before you co-sign, be sure that you can afford to pay off the debt – the amount of that loan – if the borrower defaults. If it’s going to hurt you financially to assume the payments, co-signing a loan probably isn’t the right idea,” Ms. Lucreziano says.
There is also a potential of loss of assets if payments aren’t made and the lender takes action to seize the assets, she adds. “That’s maybe an extreme case, but it absolutely can affect you that way.”
If you say “yes,” she advises to make sure it’s because you’re confident the borrower is financially responsible and has a solid plan to repay the loan in full and on schedule. Also, ask the borrower about their “Plan B.” For example, where will the loan payments come from if their income is interrupted? Do they have an emergency fund?
“The reality is, you don’t want to be that Plan B,” Ms. Lucreziano says.
To say “no” diplomatically, she says expressing gratitude for the borrower’s trust and confidence in your financial stability, explaining clearly the reasons why you can’t co-sign. Perhaps it’s because it means risking your own financial goals. Then, offer to connect them with a financial professional who can help them explore saving and financing options.
Consider alternatives
Yet, there are good reasons to step in as a co-signer, says Tony Maiorino, vice president, director and head of RBC Family Office Services at RBC Wealth Management in Toronto. A borrower with past credit issues may now have a stable job and the capacity to repay a loan but be unable to get a loan at a reasonable rate without a co-signer.
An adult child who has never had debt before may need to establish a credit rating with a co-signed loan or mortgage. That last one is something Mr. Maiorino has thought about in relation to his own daughter.
“I’m going to want to ask some good questions and make sure she’s not overextending herself … but I certainly would be willing to do that,” he says.
Mr. Maiorino adds it’s worth exploring alternatives to co-signing as well. If a mortgage application is being turned down because the down payment is only 10 per cent, maybe a parent would prefer to give an adult child an early inheritance to create a larger down payment. Or perhaps a parent could offer free rent and board in their home for a period of time so children can save toward whatever they want to buy with the co-signed loan.
“There’s an opportunity for people to have a conversation around what’s the best way to support [the borrower] toward the end goal,” he says.
Another benefit of having in-depth conversations about co-signing is that sometimes it becomes very clear to both parties this isn’t the right move.
“If you’re asking the right questions at the front end, it can become pretty self-evident this is not something that’s in the best interest of the person asking to borrow the money [or] for you as a co-signer,” Mr. Maiorino says.
And if it’s clear to you but not to the borrower? “You just need to be honest and say … ‘This isn’t the right opportunity for me to help out. Maybe I can help out in another way,’” he says.
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