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Want to Stop Getting Into Debt? Quit Doing This One Thing

03/10/2015 06:06 pm ET | Updated May 10, 2015

I know someone whose 20-year-old niece wanted to buy a new car. She asked her grandma to co-sign for the car loan, but grandma said, "I love you. But no, I will not co-sign. If you miss a payment, I'm responsible." So, the niece turned to her mom who couldn't say "No" and co-signed the car loan. Doh!

Who's Liable for a Co-Signed Loan?

According to an article on Bank Rate, a 78-year-old father lost his house because he co-signed a loan for his daughter that came due. She didn't pay and he lost his house. The daughter also defaulted on a van her father co-signed years ago; the daughter filed bankruptcy and was discharged. The car loan lender sued the father for payment. But he lives on social security and doesn't have any assets. The father hired a lawyer (costs more money) and should be considered "judgment-proof" since his only source of income is social security.

Sadly, the above situation is not uncommon. Co-signing for a car loan, private student loan, or anything else is one of the worst financial mistakes you can make. Why? Because according to the FTC, lenders can collect from you immediately.

Keep in mind that when you co-sign a loan, you're vouching for that person. Are you sure your college-bound son or daughter can handle private student loan repayments? More importantly, are they ready for college?

If you're considering co-signing a loan, you better make sure you have the funds to make payments. Why? Because if the person you've co-signed for refuses to make payments, you're liable.

Do you have plans to purchase a home? Then you better think twice about being a co-signor on your sister's loan. If you've co-signed a loan, you may not be able to get a loan because lenders have tightened requirements.

Finally, if you've put your car, house, or something else of significant value as collateral, you may lose it in less than 60 seconds. Is that what you want? Probably not.

Refusing to Co-Sign a Loan Keeps You Out of Debt

While it may pain you to refuse family and friends who ask you to be a co-signor, it will keep you out of debt. Here's how:

Student loan debt is about $1.2 trillion and most likely won't decrease anytime soon. Why? One reason is that these loans can't be discharged in bankruptcy. But you can avoid contributing to the rise of student loan debt by not co-signing for your child's private student loans. If your child wants to attend a college or university, help them research scholarships and grants. Many college kids fund at least 50% or even their entire college tuition with these financial resources. It's possible, but research takes work.

Do you want to risk your money? How does that make you feel? It's understandable that you want to help family and friends. However, you can't control whether or not they pay their loan and pay on time. You have the potential to get into debt or deeper into debt. Plus, you risk lowering your credit and FICO scores.

If you allow people to guilt you into doing things, it's time to stop it. You're putting your financial future on the line for what? A motorcycle, car, college education, home, and other material things. Or perhaps it's a business that someone may not even be qualified to run or isn't 110% passionate about growing. Refuse to co-sign and keep yourself out of debt.

I Don't Want to Get Into Debt! But I Want to Help

Not only does co-signing a loan risk your savings, investments, and retirement funds, it puts your relationship on the line. What happens if you co-sign a loan for your best friend of 20 years, but he refuses to pay the loan? Worse yet, what if he skips town? How would that make you feel? Sad? Angry? Disappointed? Of course, if you refuse to be a co-signor, your best friend may be sad, angry, and disappointed. However, it's best to err on the side of caution and not co-sign for a loan.

Help those you love research ways to create and stay on a budget, find better or additional employment, and other financial opportunities that may help them pay for whatever it is they want. You may also consider giving your family member or friend a specific amount of money to be or not be paid back, that's up to you. Lastly, if you're not scared about getting into debt and choose to co-sign a loan, make sure you name is on the title, deed, etc. This gives you recourse if it needs to be sold, sold at auction, or repossessed.

People Who Paid Off Their Student Debt Super Fast