Co-sign is a trigonometric function, not a financial strategy

 

 

***Yes, I know it’s spelled cosine. But clever titles should never be tossed aside for silly things like the English language or spelling.

This post will anger people. I just know it will. It will anger people who have recently co-signed on a loan for a loved one. It will anger people who have recently had a loved one co-sign on a loan. And it will anger people who have co-signed on a loan, yet weren’t burned.

As you may or may not know, some lending institutions may ask for a co-signer when the primary borrower doesn’t appear to be a good credit risk. When a person becomes a co-signer, they are essentially promising to pay back the loan, in the event the primary borrower can’t handle the loan payments. At first glance, this doesn’t necessarily sound like a terrible idea. But it is. With very few exceptions, I find this to be an irresponsible thing to do. I believe most people are put in a tough situation, when asked to co-sign, and they generally acquiesce due to guilt.

Don’t get me wrong, there’s a ton of pressure and emotion revolving around co-signing. “Don’t you trust me?” the borrower might ask. But co-signing isn’t about trust. It’s about risk. Risk and trust have very little to do with each other. Do you know who specializes in risk assessment? Lending institutions. Do you know who doesn’t specialize in risk assessment? Biased family members. As much scrutiny and criticism as banks receive, they still serve an important purpose in regards to loan underwriting. If a bank says no, then why should you say yes? When you co-sign, you are essentially underwriting a sub-prime loan. This is tricky territory. People love to get mad at banks for loaning money to people they shouldn’t. Why would you loan money to someone you shouldn’t?

I feel a miniature rant coming on.

Ok.

Here’s my mini rant.

People love to get salty at the banks for sub-prime lending practices. In other words, people love to blame banks for lending money to people that can’t afford to borrow money. This is commonly classified as predatory lending. While I certainly think some predatory lending exists, it’s not forced lending. You don’t have to borrow money. You don’t have to buy a house. You don’t have to buy a car. What? You didn’t know you had a ridiculous interest rate? Shame on you, not the bank. If you default on your loan, then the bank was correct in charging you so much in the first place. They knew you were a tough risk. And they charged you a premium for being a sub-prime case. Not everyone has proven himself or herself to be a good lending risk. We can’t circumvent reality, and turn into ogre-chasing villagers. The banks have plenty of blood on their hands, but lending money to people that shouldn’t borrow it, isn’t their cross to bear.

Whew. I feel better.

This isn’t a credit score discussion either. Earlier this year, a young guy came to me with no credit. NO CREDIT. In the eyes of the credit agencies, he hadn’t done enough to register a blip on their screens. I started poking around this guy’s finances, and quickly realized that he was doing a helluva job. He had very few financial obligations, and he had accumulated $50,000 in savings. He wanted to buy a home. I directed him to a lending institution that I knew would assess the risk involved with lending someone with no credit, money to buy a house. They assessed the risk. Decided that his credit score, or lack thereof, was irrelevant. They loaned him money to buy a house.

As cliche as this has become, isn’t this an extension of the participation trophy problem? There’s no way that every kid deserves a trophy. And there’s no way everyone has earned the right to borrow money. Not everyone has proven himself to be a good risk. Family members shouldn’t mess up this financial natural selection. Your kid isn’t missing out, when a bank tells him or her no. It’s feedback. Your kid is being told he hasn’t done enough to display his credit worthiness. This isn’t a bad thing!!!! When someone is denied a loan, it should be celebrated. Unfortunately, most people view a loan declination as some sort of insult. It’s not. You should take no for an answer. Take that no, work on your skills, and then come back later to get a yes. How long will the person need to wait? Longer than he or she wants to.

It’s not that different than letting your kid ride a carnival ride, despite the fact they aren’t “this tall.” Sure, you can probably talk your way past the carny, but should you?

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