It's okay to say no to co-signing a loan

During my first marriage, my wife once asked if she could co-sign a lease for a friend of hers that was having trouble getting an apartment. I thought about it, then said I didn't think it was a good idea and not to do it. Naturally, that sparked a pretty loud argument between us about the merits of helping out a friend in need versus the merits of protecting one's own financial interests. In the end, I refused to budge and my wife was respectful enough of my feelings to tell her friend, "Sorry."

At the time I wasn't sure I was doing the right thing. I knew the friend and felt bad that she needed a co-signer, due to circumstances which weren't entirely her fault. And she seemed genuinely trustworthy, a "good person."

Co-signing is poor judgment
As my knowledge and experience in personal finance has grown, I've learned that my first instinct was right. Co-signing for the debt of someone else, whether a friend or (as in most cases) a family member, is not wise. In fact, Proverbs 17:18 says, "It is poor judgment to co-sign a friend's note, to become responsible for a neighbor's debts." (New Living Translation).

Why? Co-signing means that you accept total responsibility for repaying the loan if the primary borrower fails to. Many times lenders want a co-signer for understandable reasons--a borrower is very young or hasn't established a credit history, perhaps. But often it's because the person has been irresponsible in paying back borrowed money in the past. You are essentially taking on risk that the lender--which probably has more assets and resources than you do--won't.

You really could pay
Additionally, co-signers pay back someone else's loan more often than you probably think. The Federal Trade Commission says that "studies of certain types of lenders show that for co-signed loans that go into default, as many as three out of four co-signers are asked to repay the loan." (View the full article.) If the loan goes into default, it shows up on your credit report as well as the primary borrower's. And it also counts as your own debt, which could prevent a lender from loaning you money directly.

Family members are often the first to ask you to co-sign, and are often the hardest to turn down. But there is no guarantee that a son, daughter, brother, or sister would be a better borrower. A father I know co-signed a loan for his son, then was surprised to get a collection notice from the bank. The son had never mentioned he had been unable to make the payments, and the father ended up paying the balance.

You can still be supportive
If someone asks you to be a co-signer, consider it carefully. Ask yourself if you could afford to step in should the borrower fall behind on payments, and if you're willing to assume the risk. If not, your answer should be a firm "no."

Instead, offer a cash gift to help the person if you can. Collect money from friends or family members on the person's behalf. Contact your church about possible financial help.

If a friend or relative is hurt or offended by your response, empathize with their feelings, but keep the guilt at bay. Ultimately, you could be helping them. You may be keeping them out of a loan that they in truth may not be able to pay back, which would worsen their situation overall.