What Does It Mean To Cosign A Loan; All You Need To Know

Cosigning a loan can be a generous thing to do for a loved one, but there are some things you should know before you sign up for it.

If you have a good credit score and are financially stable, then there is a high chance that someone might ask you to cosign a loan. The people on the asking end will usually be your friends or family.

Before you get generous and agree to anything, be sure to know what does it mean to cosign a loan. There can be a lot of risky situations for the cosigner, so it is better to identify alternatives to cosigning a loan and check the cosigner requirements, so see whether you qualify or not.

What Is A Loan Cosigner

A loan cosigner is an individual who jointly signs a loan with the borrower. By doing so, the cosigner will be responsible for paying the mortgage or loan and completing the payments if the borrower is unable to do so.

A cosigner is helpful when an individual doesn’t have a good enough credit score. In such situations, a cosigner can help a lot in adding credibility to the borrower’s image. Furthermore, people with good credit scores will also get relatively fewer interest rates, which means lesser monthly payments.

Cosigners are an excellent solution for first-time borrowers as it helps give them a little boost. Is cosigning a loan a good idea, though? It can be risky as cosigning means taking on the responsibility of playing if the borrower can’t go through.

Cosigner Requirements

There are also specific requirements that a cosigner has to fulfill if they want to cosign. All of these requirements are to show that a cosigner is financially stable. Lenders are trying to look for ways to lessen their risk, and a cosigner can be the scapegoat for them.

1.   Credit Score

The first essential requirement that all lenders look for is a good credit score. Although there is no strict cut-off, a lot of lenders prefer their cosigners to have an excellent credit score. The preferred credit score can range from lender to lender, but 700 is considered to be a high credit score and will be perfect for a cosigner.

It is mainly for all those who do not have an excellent credit score. With a cosigner’s high score, the lenders will be assured that there is someone financially responsible behind the borrower. It can make getting loans for first-timers very easy.

2.   Proof Of Income

Next up, a cosigner also has to give a proof of income to the lender. It helps the lender reduce the element of risk by ensuring that a cosigner has a steady flow of income. It can only be possible if the cosigner is employed at the time of signing the loan.

The lenders will ask for proof of income in the form of payslips, wage vouchers, etc., to make sure that the income flow is steady. Moreover, some lenders might ask for income tax returns too.

Out of the list of cosigner requirements, if an individual is unable to fulfill proof of income, then there is a high chance of the lender not giving the loan. With the income figure, banks can easily calculate the debt to income ratio.
This ratio is calculated by summing up all the bills and debts(including the one they will have to give if you can’t) that they have to pay in a year and divide it by their monthly income. If the debt to income ratio comes out to be less than 50%, then the cosigner will be quickly approved.

3.   Level Of Stability

In a few cases, banks will try to takes a look at the cosigner’s finances and employment to make sure that they would be able to pay back their loans. Banks can check the level of stability from a few things. Firstly, the lender will ask for the residential address of the cosigner. It can help the bank confirm that the cosigner hasn’t been continuously changing places.

Next up, an employment summary is also given to the bank. Employment in the same firm for a few years is a sign of stability as well. Again, constant changes in work can also be a bit of a setback.

Is Cosigning A Loan A Good Idea

Co-signing a loan can leave you in a high-risk situation. Some things that can happen are:

1.   Long Term Commitment

Cosigning a loan is a long term commitment. You will be a part of the contract for as long as the borrower is paying it back. You cannot back out of it midway since it is part of a legally binding agreement.

2.   Unable Borrower

A significant problem in signing is that the borrower might not be able to make the payments. Once this happens, you will be utterly responsible for paying the dues.

3.   Messed Up Credit Score

The credit score can also get messed up if the borrower is unable to make a payment. Since you are linked to the same loan, and any discrepancy will come on to you as well.

4.   Relationship Troubles

Lastly, not a financial con, but cosigning a loan can also wreck your relationship with the borrower if they are unable to pay it back, and you will be on the spot. It can also be trouble for you if you have a fallout, and they suddenly vanish, leaving you to complete the dues.

What Are Some Alternatives To Cosigning A Loan

Now that we’ve figured out what loan cosigning is, we can see how there is a lot of risks involved for a cosigner and just the benefit of helping someone. It can be quite challenging to say no upfront to your loved ones if they ask you to co-sign a loan.
One should always be aware of some alternatives to cosigning a loan. You can suggest these and pick out one that suits them the most.

1.   Down Payment

The easiest way to get out of a loan cosigning is by helping the borrower with the downpayment. By doing so, the borrower will automatically back down from taking the loan, and you will be out of the equation as well. Since a down payment can be a lot of money, you can decide to give it as a present, or you can lend it to them.

2.   Lend The Money

Now, if you don’t want to give out a massive sum for the down payment, you can simply tell the borrower that they can lend money from you if they land in a hard spot. Giving money is a very convenient and foolproof method to make sure that you don’t get bound up in contracts with any lending company.

The borrower can pay back the amount they borrowed from you in a duration decided by the both of you. The benefit of loaning the money form you is that they won’t have to pay you any interest charges so that it will be beneficial for them as well.

3.   Do the Loaning Yourself

Here is another one in the list of alternatives to cosigning a loan. You will need to sign two contracts for this one. The idea is to get a loan yourself, give it your loved one and then make another contract with the said loved one who wanted the credit in the first place. In this new contract, you can make the borrower put up anything as collateral, and they have to pay you back the loan amount in a specified duration.

It won’t help in building their credit scores since this will be a personal loan, but once again, they will be safe from the hassle of interest charges.

4.   Better Options

The need for a loan comes up when one is spending more than they could afford. If someone you know is getting into an expensive deal and have to resort to taking loans, you can always help them is looking for better deals. The trick is to find an offer that doesn’t cost them as much but will also be something they approve.

Even if the new deal is a little pricey, they can take out a smaller loan and cover it. You won’t be hassled into cosigning a loan like this.

Nabeel Ahmad

Nabeel Ahmad

Nabeel Ahmad is the founder and editor-in-chief of Insurance Noon. Apart from Insurance Noon, he is a serial entrepreneur, and has founded multiple successful companies in different industries.

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