Understand what it really entails if you're considering co-signing a loan for someone.
 
A co-signer may be required for a creditor to approve a loan when the applicant doesn't have the credit history that a lender requires to approve the loan - maybe they have no credit history or a poor credit history.  A co-signer may be required for an auto loan, a personal loan, or even a home loan.
 
The main benefit to getting a co-signer is that the lender will base the credit decision and the credit terms on the co-signer's credit history rather than that of the applicant.  This can mean the difference between getting a good interest rate or having to resort to a higher cost loan for people with a poor or limited credit history.  It can mean the difference between getting a traditional auto loan with fair credit terms and having to buy a car at a buy-here-pay-here lot with a typically expensive interest rate.
 
The main drawback in this situation is that the co-signer is taking responsibility for the loan in the case that the borrower defaults.  The co-signer is literally putting their good credit on the line.  The co-signer will have to come up with the payment themselves to prevent damage to their own credit rating if the borrower doesn't follow through and pay the monthly payment on time.
 
What would you do if a friend or relative asked you to cosign a loan? Before you answer, make sure you understand what co-signing involves. Under federal law, creditors are required to give you a notice that explains your obligations. The co-signer’s notice states:

 

You are being asked to guarantee this debt. Think carefully before you do. If the borrower does not pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.

You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount.

The creditor can collect this debt from you without first trying to collect from the borrower.* The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become a part of your credit record.

This notice is not the contract that makes you liable for the debt.

 
* Depending on your state, this may not apply. If state law forbids a creditor from collecting from a co-signer without first trying to collect from the primary debtor, this sentence may be crossed out or omitted altogether.
 
The Federal Trade Commission says that as many as many as three out of four co-signers are asked to repay the loan when the loan goes into default.  When you're asked to co-sign, you're being asked to take a risk that a professional lender won't even take.  
 
In most states, if you co-sign and your friend or relative misses a payment, the lender can immediately collect from you without first pursuing the borrower.  In addition, the amount you owe may be increased — by late charges or by attorneys’ fees — if the lender decides to sue to collect.  If the lender wins the case, your wages and property may be take.
 
Understanding the risk involved, you may still want to co-sign for someone.  It may be your young adult child who needs a loan for their first car, or your spouse may not have established their credit on their own yet.  You can help them get a better loan by doing it for them, but before you co-sign, keep this information in mind:
 
  • Be sure you can afford to pay the loan in case of default.  It is only smart to anticipate the worst, and don't do it if you can't afford the payments.  If the lender asks you to pay and you can't do it, you could be sued and your credit rating could be damaged. 
  • Co-signing for the loan may hurt your ability to gain new credit elsewhere.  Creditors will consider the co-signed loan as one of your obligations, even if you haven't been asked to repay the loan.
  • Before you pledge property to secure the loan, such as your car or furniture, make sure you understand the consequences. If the borrower defaults, you could lose these items.
  • Ask the lender to calculate the amount of money you might owe. The lender isn't required to do this, but may if asked. You also may be able to negotiate the specific terms of your obligation. For example, you may want to limit your liability to the principal on the loan, and not include late charges, court costs, or attorneys' fees. In this case, ask the lender to include a statement in the contract similar to: "The cosigner will be responsible only for the principal balance on this loan at the time of default."
  • Ask the lender to notify you right away if the borrower misses a payment, and get the agreement in writing.  That way you you'll have time to deal with the problem directly with the borrower or make back payments without having to repay the entire amount immediately. 
  • Make sure you get copies of all important papers, such as the loan contract, the Truth-in-Lending Disclosure Statement, and warranties — if you're cosigning for a purchase. You may need these documents if there's a dispute between the borrower and the seller. The lender is not required to give you these papers; you may have to get copies from the borrower.
  • Check your state law for additional cosigner rights.
 
 
 
Source:
Federal Trade Commission