Serving as a co-borrower on a housing loan can be an awesome good deed, but it also puts you at some risk. For every responsible relative who deserves your help in securing a bigger loan, you’ll find plenty of others who run the risk of defaulting, leaving you to carry the bag.
What exactly does it mean to be a co-borrower on a loan? It means you’re lending your own good credit—you, along with the main borrower, become just as responsible for the payment of the loan, even if you’re not shelling out any money. If the main borrower fails to meet his payment obligations, the lender can go after you instead. If it all goes wrong, your net worth will take a hit, not to mention your credit standing.
So before you sign on the dotted line…
1. Know who you’re signing for. Co-signing on a housing loan is not the same thing as providing a character reference. As a co-borrower, you can be found jointly and severely liable for the loan; you assume the duty of paying off the loan if the main borrower fails to hold his end up of the deal. So don’t take the obligation lightly.
Make sure the person you’re co-signing for can be trusted to pay off the loan. Be realistic about the person’s capacity to pay. If you have your doubts, proceed only if you have the financial muscle to assume the balance the borrower may eventually default on.
Chances are, you are a close relative of the main borrower: for major commitments like housing loans, “some lenders are wary of those who co-sign, allowing only parents and close relatives to co-sign,” notes Armando Ang, author of Tips and Traps When Buying or Building a Home. “If the cosigner is one of those big-time businessmen, there should be no problem with the credit investigation.”
2. Try to limit your liability. Don’t risk your financial position any more than you need to. If you can manage it, ask the bank to limit your responsibility to part of the loan—maybe you can co-sign on just the principal, not the whole thing.
Check with your lawyer to see how little of yourself you can leave exposed to risk. That may be easier said than done—“some lenders may insist that co-signers also appear as co-owners during the duration of the mortgage,” reminds Ang. Ask your attorney about the implications of your decision, and don’t forget to collect copies of all the vital paperwork.
3. Hope for the best, prepare for the worst. Ask yourself: in the worst case scenario, are you financially prepared to assume responsibility for your relative’s debt? Talk with your lawyer, and draw up plans that you can put into effect in case the borrower defaults.
Once the loan has been approved, keep tabs on the borrower. Insist on monthly updates. Ask for statements, receipts or other evidence that show how the borrower is meeting their obligations. For instance, you might request a duplicate of the monthly statement, or request online access to track payments. Do not lose contact with the principal, and be proactive if the principal shows signs of being unable to do their duty.
Being a co-borrower on a housing loan is tricky—it leaves you with few benefits, but plenty of obligations. For older, more stable relatives trying to give their younger kin a step up in life, being a co-borrower can be its own reward, particularly if the borrower finishes the loan term without risking you or your credit standing. Just do your due diligence so that good deed doesn’t risk your bottom line any more than necessary!