Understand what it means to co-sign with someone.
Getting a loan is not usually an easy process. There is a lot that goes into being granted a loan. From applying for it to submitting documents for loan underwriting, the entire process can be quite a hassle.
However, it can be fairly easy if you know what you are getting yourself into by making sure you know everything about it. For example, what is a cosigner on a loan and whether you need one.
What is a Cosigner on a Loan?
When you cosign a loan, you are making a promise to pay off somebody else’s debt in case the borrower stops making payments for any reason. This is usually done for a friend or family member as it is quite a generous act for someone who would not otherwise be approved for a loan. This usually happens when one person does not qualify for a loan. But as you might imagine, taking a guarantee for someone else can be very risky which is why you should only do it if you are absolutely sure about it.
To cosign a loan, you and the borrower are required to fill out a loan application and you agree to pay off the loan. This application could either be online or on paper which you then sign taking on the responsibility to repay the loan.
The main use of a cosigner is to help a borrower get approved for the loan. It is difficult for some borrowers to qualify for a loan on their own. It may be because of their lack of income to cover the loan payments or their credit scores may be too low to qualify. In some cases, credit history is important since any problems in the past can disqualify them. And some just do not have a sufficient borrowing history to qualify. This is where the cosigners come in.
And in case you are wondering, what credit score does a cosigner need? It is usually recommended for a cosigner to have a good credit score and good credit history in order to qualify and take on the risk for the borrower. What qualifies as a good credit score can be checked online as every loan is different and has different requirements.
Cosigners need to have enough income and sufficient credit scores as they are the ones strengthening the loan application. If you are a borrower with a poor credit score or no borrowing history, having a cosigner that qualifies on your loan application can help you get approved.
Risks of Cosigning
It can be very generous helping someone get a loan. But before you attempt to do that, you need to understand the risks of cosigning.
The reason the lender even wants a cosigner is because they do not have faith in the borrower’s abilities to repay in full and on-time. If a professional lender does not have the confidence, it must be for a reason. Lenders have access to data and have extensive experience with borrowers. It would be risky for you to take up the guarantee of repaying that loan. This is usually only done for family as the fact that they are your family is enough of a reason for people to take on the risk knowingly.
It can also provide damage to your credit if the borrower fails to repay the loan and your credit suffers along with the primary borrower’s credit. If the borrower makes late payments or misses any of them, it will not only appear on the borrower’s credit report but also your own credit report which will lower your credit scores. As a result, it will get harder for you to get loans in the future and you may have to suffer from higher insurance rates if you ever choose to get insurance. Now, the question arises, who gets the credit on a cosigned loan? Similar to the damage done to you and the borrower both, the credit will also be received by you and the borrower both.
Moreover, if you agree to cover the loan, you will be 100 percent responsible to repay the loan and come up with the required payments. You may also have to face late fees as well on top of those monthly payments. It would not matter if the borrower has more money than you. All that matters to the lender is getting their payments and they will collect from wherever possible.
When you cosign, you are agreeing to put yourself in the middle of the lender and borrower. The lender would also prefer to get the funds from you as you seem like the easier option. The lender would not even care why the borrower is no longer paying as long as you are there as a cosigner. The borrower could have lost a job, pass away, disappear or become disabled. The lenders would not care about that and will send you letters and call you in order to collect the payment.
You might even have legal judgments against you if you fail to respond. These attempts to collect also appear on your credit reports and may cause further damage. Lenders may also be able to garnish your wages and take assets from your bank accounts if you do not willingly make the payments. This is a lot of risk that should not be taken lightly.
Moreover, when you cosign a loan, you send an impression to other borrowers that you are responsible for the loan, making them assume that you will be the one making payments. Cosigning can end up reducing the amount of your monthly income that you could have used on new loans. And even though you are not the primary borrower, it could end up being harder for you to qualify for loans you might actually need for yourself, even if you do not make a single payment on the cosigned loan. This can prevent you from taking out a loan to buy a home or automobile when you need to.
Cosigning also means entering into a long term relationship. Lenders would not want to let you off the loan as they would now have more than one person to collect from, reducing the overall risk of lending. You can choose to remove yourself from the loan or get a cosigner release but this does not have the way out you would want.
So as you can, there is a lot of risk involved when you cosign for someone and become responsible for their debt. Even with all this responsibility, you will not be getting anything back. You will not be the owner of whatever it is that the borrower buys or have any right to the property on the basis of you being the cosigner. There might be some legal procedures you might be able to follow based on the situation that can give you back some of what you have lost but it is best not to get your hopes up as this does not usually work out in the cosigner’s favour. Even if you get something back, the time and energy you would have spent will be lost for good. If you are someone who does not like taking on a risk, we would suggest you to avoid cosigning and so would anyone else.
However, there might be some not usually likely situations where cosigning can, we will not call it a good idea, make sense.
Benefits of Cosigning
Even though cosigning is always risky, there are very few instances where you might cosign and it would make sense. For example, if you can afford the risk and want to cosign then you could easily go ahead and do it.
Affording the risk means you have plenty of extra cash and substantial assets to pay off the loan if your borrower fails to. However, it is still essential to verify if you will be able to qualify for any potential borrowing that you might need in the future. It is important to be prepared to afford the risk but it is even more important to absorb losses at any time in the future if your borrow defaults.
Moreover, if you truly start borrowing with someone, it would just make more sense for you to co-sign. For example, buying a car that will be in your household with your partner who just needs a little boost will only make sense. But even in situations like this, you can be a co-owner of the car and apply for the car loan jointly. You can find out how much does a cosigner help on auto loans from a professional in order to make the best decision for your family.
Another situation in which it would make sense for you to cosign would be if you wanted to help and there were no other options. You will have to take substantial risks but if you desperately want to help someone, these risks might not matter for you. Maybe it will all work out fine. But you should be prepared for things to go south no matter what.
Alternatives to Cosigning a Loan
Before you decide to cosign a loan, you should take a look at the alternatives to see if you can find one that would fit your needs.
- Instead of cosigning, you can help the borrower with the down payment of the loan instead. It would save you from the risk while also helping out the borrower. If you provide a bigger down payment, you could lower down the required monthly payment for them making it easier to repay the loan if the borrower has limited income. This would obviously require you to have substantial cash in hand that you would be willing to spend. You should also be willing to communicate how that down payment needs to be handled. You should discuss whether it is a gift or if you need to set up a formal private loan agreement for the borrower to pay it back.
- You can also lend the money yourself, which will be called a private loan if you believe that there is a high risk of default. This would again require you to afford losing the money. It is important to communicate about all the terms and conditions about this private loan agreement and also put it in writing. This would make you the bank and let you provide help to someone who needs it. However, these loans can end up making relationships awkward and ruining them. It might also be hard for the borrower to build credit like this.
How Does Cosigning Help Build Credit?
If you have decided to cosign, you can help build credit by making sure the account has been paid on time which will add to your payment history. If you have a good credit score, you would be at more of a risk as the effect may be small compared to the destruction the borrower can cause to the score by not paying. You might be able to get a small benefit if your credit mix improves.
However, the person you cosigned for can qualify for credit that they otherwise would not have been able to get resulting in them being able to get closer to having a good credit score. Making on-time payments on the account will also help build up a good payment history for the borrower which can help them qualify for and secure other loans in the future.
The Bottom Line
So to conclude, not only do we have the answer to the question, “what is a cosigner on a loan?” but we also have determined why being a cosigner is never a good idea. Even when you are desperate to help someone and do not have other options, you are still taking on a lot of risk. Moreover, if you can afford the risk, it can still affect you in other ways such as, by lowering your credit score and making you unlikely to qualify for another loan in the future.
Thus, the conclusion is, if you can avoid cosigning a loan, do it!