How to Co-sign a Loan: The Risks and Benefits
What is a co-signer?
Co-signers are people who sign on to the primary borrower’s loan application. They agree to legally be responsible for the loan amount and any additional fees if the borrower cannot pay.
Co-signers are often needed or desired by most people who can’t get a loan on their own. A co-signer can be someone with a good credit rating or a thin credit history to increase their chances of getting a loan.
A co-signed loan is different from a joint loan where two borrowers have equal access, as the cosigner does not have any right to the money, even though they may be responsible for repayment.
Co-signing a loan is risky
You are in a unique position if you co-sign on loan for someone else. Consider the benefits and risks of cosigning on loan for someone else. Also, how to protect your relationship and finances.
- The entire amount of the loan is your responsibility
This is the riskiest: Co-signing for a loan does not mean you are lending your credit history to someone else. They promise to pay the debts they have incurred, late fees, and collection costs if they fail to pay them.
Be sure to assess your financial situation before you agree to co-sign.
- Your credit is on the line
Co-signing a loan can result in both the loan and the payment history being included on your credit report and that of the borrower.
The spokesperson for National Foundation for Credit Counseling, Bruce McClary, said that you would see a temporary drop in your credit score for the short term. He says that the lender’s rigorous credit check on you before approving the loan could affect your credit score and increase your overall debt load.
Significantly, however: A missed payment by a borrower can negatively impact your credit score. Poor payment history can have a significant impact on your credit score.
- You may lose access to credit
Co-signing a loan on behalf of a loved one can lead to you being denied credit. When calculating your total debt, potential creditors will consider the co-signed loan and may not extend credit to you.
McClary suggests that you regularly check your credit reports after signing to monitor your finances.
- The lender could sue you
According to the Federal Trade Commission, in some states, if the lender fails to receive payments, it may try to collect money from the cosigner before going after the primary borrower.
The borrower would have likely missed several payments, and the debt would have already started to impact your credit score. Lenders will probably consider legal action if the debt is 90 to 180 days past due.
If you are sued for nonpayment, and the worst happens, you will be responsible for all costs, including attorney’s fees.
- Your relationship may be at risk
With good intentions, the borrower might start making regular payments towards the loan or credit card. However, financial and personal circumstances change.
Children in trouble for payments towards a co-signed car loan or credit card may conceal the problem from their parents until it becomes worse, ruining the trust and causing irreparable damage to the relationship.
According to Urmi Mukherjee (certified financial counselor at Apprisen), a non-profit financial counseling agency, divorced couples often have to deal financially with co-signed cars or mortgages. It can be difficult to convince one spouse to pay their share in these cases, especially if they have moved out of the home or given up the car.
- It’s not easy to remove yourself from a cosigner.
It is sometimes difficult to remove yourself from co-signer status if there are problems.
If the primary borrower is no longer eligible for a loan, refinancing can be a way to get yourself out of debt. Students loans and credit cards require that the borrower make regular payments to make the loan payments.
Co-signing a loan is a benefit
Co-signing a loan is a great way to help someone get a loan. You can help them earn college tuition, a credit line, or any other financial product that they might not be able to obtain on their own. Or, you can save them interest at a lower rate.
A co-signer with a strong credit score and a history of financial success is a powerful tool for someone new to credit or rebuilding their finances.
Is co-signing for a loan a way to build credit?
These are some of the ways that a cosigner can help you build your credit:
- It adds to your payment record as long as you make timely payments. If you have good credit and a history of paying on time, it may not be as significant as the risk to your credit score if the borrower defaults.
- If your credit score improves, you might see a slight benefit. You can have both installment loans with level payments and revolving credit accounts, such as credit cards.
These are some ways that the person you cosigned for can improve their credit score:
- This can make it easier to get the credit they wouldn’t otherwise obtain and help build a credit history.
- Good payment history is built by making timely payments to the account.
How to protect credit when you co-sign for a loan
Ask the lender before you sign a co-signing agreement. Find out what your rights are and how you will be notified if there are any payment problems.
Ask the primary borrower to access the loan account so that you can track payments,” says Byrke Sesok, a New York-based certified financial planner at Rightirement Wealth Partners.
Sestok states, “It’s no trust issue — problems can happen.” You can take action if you discover that someone has a problem paying back the loan.
McClary suggests that co-signers and borrowers agree to a written agreement upfront. This will help you plan for these situations. He says that a private agreement can help smoothen out expectations that are not in line with reality.
There are other options than co-signing for a loan
There are many options for the borrower if you don’t wish to co-sign a loan.
- Online lenders can help applicants with bad credit. Online lenders don’t have as strict requirements as banks and can evaluate other factors, in addition to credit score. Online lenders may charge higher interest rates if you have poor credit. Annual percentage rates are typically higher than 20%.
- Collateral: Borrowers might be able to offer collateral such as a home, car, or investment account. Secured loans are also known as collateral and come with their risks. The borrower will lose any asset that they have pledged if they are unable to pay the loan.
- A family loan is an option: If the borrower wants a cosigner, they can loan to their family. The family loan does not involve a third-party lender. However, it must include a notarized written agreement between the parties detailing terms. Although family loans are cheaper than predatory lenders and can help borrowers avoid prey, they can still risk another person’s financial health if the borrower is unable or unwilling to repay the loan.