McArdle Warns, 'Never, Ever Cosign A Loan'

NEAL CONAN, host: You scrimped and saved. As hard times hit, you tightened your belt and doubled down on your contribution to your IRA in the toughest time since the Great Depression. Well, you're doing OK. Then your child asks you to cosign a car loan or a college loan. It could be a mortgage, and it could be your brother, a sister, a friend, even a parent. Don't do it, not ever. That's the advice of Megan McArdle, business and economics editor for The Atlantic magazine.

So did you cosign a loan? How did it work out? And if you ever asked somebody to cosign a loan and they refused, how did that work out? 800-989-8255. Email us: talk@npr.org. You can also join the conversation on our website. That's at npr.org, click on TALK OF THE NATION.

And Megan McArdle joins us here in Studio 3A. Nice to have you with us today.

MEGAN MCARDLE: Thank you for having me.

CONAN: Going to be an interesting conversation next Thanksgiving.

(SOUNDBITE OF LAUGHTER)

MCARDLE: Well, I actually - I have to admit, my parents cosigned a student loan for them. But if I had known the risk they were taking, I don't think I would have asked them to do it. I mean, it worked out OK in my case. I'm actually three years ahead on my student loan. But that's, unfortunately, not always normal.

CONAN: In fact, the reason people need somebody to cosign a loan is their credit stinks.

MCARDLE: It can be a couple of different things. It may be that their credit is terrible. It may be that they have too much debt or that their income really isn't enough to cover the loan in the estimation of the bank. Or it may simply be that they don't have credit at all. In the latter case, there's actually other ways to deal with that to help people get access to credit to build up their credit score without actually going and cosigning a loan for them.

CONAN: We'll get to the alternatives in just a minute. But you had an interesting percentage of cosigners who end up paying off the loans because the primary debtor defaults.

MCARDLE: The data is a little bit hard to come by. But according to the FTC, depending on the kind of loan, up to 75 percent of the primary borrowers may end up defaulting on these loans, which means not only that the cosigner is going to be on the hook to pay it - something that they really usually don't expect - but also that it's going to go on their credit history. You know, when that loan isn't paid, you often don't get noticed until it's in collections.

CONAN: Well, how does that work? You're the cosigner. What's the collection process like?

MCARDLE: Well, it really depends on, first of all, the state and, second of all, the contract. But in a lot of these contracts, there is no requirement of notice to the co-payer that they're late. You don't find out until they've looked at the primary borrower's balance sheet, looked at yours, and decided that you're a better collection debt.

(SOUNDBITE OF LAUGHTER)

CONAN: And many parents can find themselves in that situation pretty quickly.

MCARDLE: Absolutely. A lot of people assume that when you cosign a loan that they will go after the primary borrower and that they will basically only come to you after they've exhausted all of their attempts to collect. And in a lot of places, that's actually the opposite of the truth. They have total discretion as to who they want to collect from. And when they're looking at it, who are they going to pick? Your kid who has no job and lousy credit, or you with lots of savings and a solid job with wages that you can garnish? I mean, it's usually a pretty easy decision.

CONAN: And once that happens, the relationship - either the child, the brother, the friend, the parent, whatever - suddenly, hey, wait a minute, what have you done to me?

MCARDLE: Right. This is the thing that people, I think, really underestimate. And often they sign these loans because they're at the car dealership and, you know, the kid is right there saying, help me get this car. And they do it to save the relationship. But in fact, you're putting your relationship in real jeopardy. It's very hard to say no. It's really difficult to say, you know, I want to help you, but I'm not going to help you this way, when what people usually want is help getting credit, not help, say, doing a budget or buying a less expensive car.

But if you become this person's primary creditor, which is what's going to happen if they default, that really damages the relationship. And even if you don't, you know, as Dave Ramsey, the financial guru, likes to say, Thanksgiving dinner tastes different when your father-in-law is asking - is looking at you across the table and wondering why you couldn't pay off your car loan and yet you have a TV or whatever. Keeping those kinds of decisions outside the family, outside of relationships is usually better for everyone in the long run.

CONAN: So let's look at some alternatives. There's one called guaranteeing a loan. Is that a better opportunity?

MCARDLE: That's basically the same thing. You guarantee a loan. You're saying I am going to pay it off if this person doesn't. You can make the loan yourself if you want to, but I don't recommend it for the same reason. When you're someone's creditor, it changes a relationship in a way that's not really healthy. But, you know, people underestimate the option of just giving people the money. And when I say this, their eyes lit up and go, I can't afford that.

But if you can't afford to give them the money, then you shouldn't be cosigning a loan, because if they default, that's what you've done. And not just giving them the money, but giving them the money plus late fees and penalties and interest. And so, if you, you know, have the ability to gift someone this amount of money, then consider just doing that, helping them to get their first car, helping them to put down a deposit on a secured credit card so that they can build up their credit history.

CONAN: Well then, you get — if it's over $10,000, you run into other problems, but...

MCARDLE: Yes. This is true. But, you know, in a lot of cases, that's not what you're really talking or, you know, people don't - usually, the people who really need this kind of help are not necessarily people who actually need $10,000. Maybe they want to buy a $25,000 car, but an $8,000 car will get them to, you know, to and from work just fine.

CONAN: Back and forth to work, yes. There was also the option, you say, of, wait a minute, why don't I give you $500 and you can start a credit card with that and build up your credit?

MCARDLE: Exactly. Exactly. And that's, you know, for people who don't have any credit history, that's a very fine way to go. Another thing that people often don't realize is that they think they need to build their credit history, because otherwise, they won't be able to get a mortgage. And that's actually not true. If you have a zero credit score, it is possible to find companies out there who'll do what's called manual underwriting of a mortgage. And so a credit history, it's valuable to have. You know, most of us are good stewards of our credit histories, but it's not something that's so vital that you want to get your credit entangled with someone else's by guaranteeing their debt.

CONAN: Here's an email we have from Matt in Honolulu. I cosigned an auto loan with my brother, which I completely regret. He is emotionally unstable. We've had a big falling-out. He struggled financially. I face a good chance of a big hit on my credit because of his misstep. I do not recommend cosigning loans, especially with family members. Though, again, it's sometimes difficult to say no.

MCARDLE: It is very difficult to say no. But when you think about it, just keep focused on how you're going to feel when he's gotten the car repo-ed, they're suing you for a deficiency judgment because there's no such thing as a non-recourse car loan. If it doesn't sell for what - the amount of the loan, they will come after you for the difference. When that's happening, how is your relationship with your brother going to be? It's a really, really tough - I don't want to downplay how tough it is to - it can be to tell people no.

But often, what people are asking for is, you know, they say they want help, but the kind of help that you can give them, say, a little bit of money, help in budgeting, they don't really want that kind of help, right? They don't want help getting their...

CONAN: (Unintelligible) a car.

(SOUNDBITE OF LAUGHTER)

MCARDLE: Right. They want a very nice car that they can't really afford. They want to not get their spending under control and to, you know, just sort of minimize their interest payments so that they can keep a lid on it, but not really address the core issues that get people into the place where, for example, the article I cited, a relative who's completely overstressed on credit card debt is asking another relative to cosign a consolidation loan for her.

CONAN: Let's talk with Bret, and Bret is on the line from New Bern in North Carolina.

BRET: Hi. Great. Thanks for having me on the show.

CONAN: Sure.

BRET: My father, from a very young age, preached over and over again, never, ever cosign; and coached me early to never ask him for a cosign for me.

CONAN: And did you ever?

BRET: No. I never asked him. Absolutely not. I knew what the answer would be.

CONAN: So you didn't even bother. And so, in that case, is there ever a situation where you wanted to ask him to cosign?

BRET: No, but I have asked - or I have had other people ask me and I told them no. Based on his story, he cosigned for some personal loans for some medical bills for a sister-in-law, and she defaulted on the loans and he had paid for those for about 20 years.

CONAN: OK. Bret, thanks very much for the call.

BRET: Thank you.

CONAN: This from Benjamin in Salt Lake City: I'm baffled by the notion people think this is a good idea. I've seen so very many relationships torn apart, especially grandparents not speaking terms with the delinquent teens or young adults that didn't make the loan payments. In my eight years of retail banking, I have yet to see the situation turn out for the positive. If you don't qualify on your own, there's good reason the bank won't make the loan to you. What makes the grandparent or anybody else think they know better than the bank underwriter? My grandfather told me when I was very young, he said, I have money and I have friends, and I have them both because I don't mix them. I have to say that advice has served me very well.

MCARDLE: Yeah. I think that that's absolutely correct. And, you know, part of it is that when people go and ask for help cosigning, it is - the bank is saying like this person is not a good risk. And you may think you know different, right? Your grandkid is a good kid, you know, really responsible. But here's the thing, what if your grandkid loses his job and he's just not going to be able to take - that's not a risk you should be bearing.

What the bank may be saying is not your kid is an irresponsible deadbeat who doesn't mail in his bills on time, but that he's really young and it's a bad economy, and that it's not a good risk to lend money - a lot of money - to someone who's been in their job for three months and doesn't have a big savings.

And so, you know, it's not just about character. It's just about kind of risk characteristics. Let the bank bear the risk for default in the event that something bad happens to your kid. They need you to be there for them, you know, financially, not entangled in their problem.

CONAN: Here's an email from Paula: We cosigned a loan for a son of ours and he walked away. And my husband is retired. I'm 65, still working. He hurt us really badly financially. He's also not spoken with us since he did this, so there is a double whammy. There's that story.

This is from Raphael: His mother, apparently, cosigned a student loan when he was going through college, but he had to make the payments. Through life, she struggled with a credit score that was always on the bubble. But because of my consistent and on-time payment schedule, it ended up improving her credit score. She eventually qualified for a mortgage on her home. So there's one where it worked out. And let's talk with Rick, Rick with us from Cincinnati.

RICK: Hi. Yeah. My brother asked me to cosign a note, and I was kind of very uncomfortable doing it. I wanted to preserve my relationship with him, of course. So offline, I just contacted the lender and asked the lender to tell my brother that I was unacceptable as a cosigner.

CONAN: Ooh. And was the lender willing to lie for you?

RICK: Absolutely. They don't want a cosigner that doesn't want to do it.

MCARDLE: That is a very interesting strategy and I think, you know, not necessarily a bad one. It's, you know, I do not normally advocate lying to your family members, but if it's a sort of thing where you really can't, you know, you need to preserve the relationship, get the lender involved and say, look, I don't want to be here and if he pushes me into this, this us going to be - make everyone worse off. Because they don't want to come after you for it, either, you're right.

CONAN: Rick, thanks very much for the call. Appreciate it.

RICK: You're welcome.

CONAN: This from - unclear as to who it's from. I cosigned for a loan with my brother for used '89 Mustang in great condition when he was in his early 20s. I was in my late 20s. Our dad would not cosign for him, though he had no reason not to. My brother always had a job and been a hard worker. I cosigned. My dad had a fit, though it was not of his business at that point. It all worked out perfectly. My brother paid it off on time. He was never late, and it was never an issue. I was glad to do it as I knew he was good for it, and no one ever did it for me. And he says thank you. So there is dad and those family obligations. The dad said no. The brother said yes, you can shop around for your - glares at the Thanksgiving table.

MCARDLE: You certainly can. People are very adept to pit one family member against the other. The only thing I would say is, I mean, it's great that he had a nice car, but you - if you're going to do something like this - and again, I don't recommend it but you really have to think about, are you helping people get something they really need? And so, you know, when people talk about, I cosigned a student loan for my kids, in a lot of ways, it's an incredibly dangerous thing to do because these loans are not bankruptable. They will garnish your Social Security payments if there is nothing else - this has happened to people - and there's absolutely no way to clear the debt.

And so, I actually really don't recommend doing this. But that's a sort of thing where you're saying the kids getting an education. There's no other way. With a Mustang, it's a great car, but was it really necessary?

CONAN: Megan McArdle, thanks very much for your time. She's a business and economics editor for The Atlantic magazine, author of the essay, "Why You Should Never, Ever Cosign a Loan for Everyone - Anyone." And she joined us here in Studio 3A. You're listening to TALK OF THE NATION from NPR News.

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