When you cosign a loan for a friend or family member, you put your finances and creditworthiness on the line. Here’s what you need to know before you cosign a loan.
A cosigner is not the main borrower. When you cosign a loan, you agree to be responsible for someone else’s debt. If the main borrower misses payments, you must make the payments. If the main borrower misses payments or stops making payments (also called defaulting), you must repay the loan.
Co-signing a loan for a family member or friend is often seen as a kind gesture, but it comes with serious risks that need careful consideration I’ve co-signed a few times in the past, so I want to share what I’ve learned about the pros, cons, and alternatives to make an informed decision before putting your name and credit on the line
What Exactly is a Co-Signer?
When you co-sign a loan, you agree to be responsible for repaying the debt if the primary borrower fails to make payments Your income, assets, and credit are factored in during the application
The main reason borrowers need a co-signer is because they can’t qualify for the loan on their own due to bad credit or limited credit history Adding a co-signer with good credit can improve their chances,
Unlike a joint loan where both parties get access to the money, the co-signer has no rights to the loan amount but takes on all the risk.
The Significant Risks of Co-Signing
Before agreeing to co-sign, think carefully about these major risks:
You’re on the Hook for the Full Balance
As a co-signer, you must be able to afford the loan payments if the primary borrower defaults. Otherwise, you’ll end up with loan payments plus fees – and a damaged credit score.
Your Credit Is Impacted Too
The hard inquiry when applying can lower your credit score a few points. More importantly, if your loved one misses payments, your credit takes a hit too since it’s also your loan.
Limited Access to New Credit
Co-signing can limit your ability to get new credit later since lenders will factor in that debt. It can push your debt-to-income ratio too high to qualify for loans or credit cards you may want.
Potential Legal Action
In some states, the lender can sue the co-signer for payment before going after the borrower. If sued, you must pay the loan balance, fees, collection costs and legal fees.
Strained Relationships
If the borrower stops paying and collectors start calling you, it creates tension. You may resent having to repay a loan that wasn’t even yours.
Difficulty Removing Your Name
You can’t just walk away if issues arise. Most lenders won’t remove your name until payments are made on time for a period of time.
The Main Benefits of Co-Signing
While the risks are formidable, the benefits for the borrower are clear:
- They can qualify for a loan or lower interest rate.
- It allows those with little credit to build it with on-time payments.
- Secures lower rates than bad credit loan options like payday loans.
As a co-signer, a slight perk is the positive payment history when the loan is repaid on time each month. But it likely won’t move the needle much if you already have a high credit score.
Alternatives to Co-Signing a Loan
If you want to help someone in need but aren’t comfortable putting your finances at risk, consider these options:
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Lend money directly: Providing a personal loan puts you in control of terms and limits third-party risk. Just be sure to draft a formal agreement.
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Help build their credit: Add them as an authorized user on a credit card you manage closely. On-time payments can quickly boost their score.
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Suggest secured loans: The borrower puts up collateral, like a car or savings, to secure the loan. This shifts risk away from you.
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Recommend credit builder loans: These specialized loans rely on on-time payments into a savings account, not credit scores, to build credit.
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Explore bad credit lenders: Online lenders may approve applicants with poor credit, but watch out for very high APRs.
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Talk through their budget: Helping organize their finances may fix issues so they can save up and avoid loans.
Key Tips Before Co-Signing
If you decide co-signing is right for your situation after weighing the risks, be smart about it:
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Review the loan terms and co-signer policies carefully. Know your rights and responsibilities.
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Check your credit and debt-to-income ratio to confirm you can handle the payments.
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Create a contract with the borrower outlining the repayment schedule and expectations.
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Request access to the loan account to monitor payment activity.
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Have a candid conversation about worst case scenarios – missed payments and damaged relationships.
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Explore options to remove yourself as co-signer after so many on-time payments.
The Bottom Line
Co-signing a loan is not merely a favor. It’s a legal obligation with real consequences for your finances and credit if things go south. Make sure you fully assess the risks and alternatives first. With good communication and protections in place, co-signing can work out between trusted friends or family. But enter the commitment with your eyes wide open.
What Are My Obligations If I Cosign a Loan?
To become a cosigner, you must sign documents that tell you the terms of the loan. Also, by law, the lender must give you a document called the Notice to Cosigner. The Notice tells you what will happen if the main borrower doesn’t pay on time or defaults. Under the FTC’s Credit Practices Rule, this is what the Notice says:
You are being asked to guarantee this debt. Think carefully before you do. If the borrower doesn’t pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.
You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount.
The creditor can collect this debt from you without first trying to collect from the borrower. The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become a part of your credit record.
This notice is not the contract that makes you liable for debt.
In some states, creditors must try to collect from the main borrower before they collect from the cosigner. If that’s the law in your state, creditors can cross out or remove the sentence in the Notice that says they can collect from you without first trying to collect from the borrower.
You may not get a Notice to Cosigner if you cosign some types of mortgage loans because federal law doesn’t require the Notice for real estate purchases. Even if you don’t get a Notice, it’s important to carefully consider the risks of cosigning.
The Notice to Cosigner should be in the same language as the loan agreement (also called the contract). For example, if the agreement is in Spanish, the Notice to Cosigner should also be in Spanish.
If I Cosign a loan, Will I get Any Ownership In the Property the Loan Finances?
No. Cosigning a loan doesn’t give you any title, ownership, or other rights to the property the loan is paying for. Your only role is to repay the loan if the main borrower falls behind on the payments or defaults.
Cosigning a loan- what you should know
FAQ
Is it good to cosign a loan?
Who gets the credit on a cosigned loan?
Can Cosigning hurt credit?
How do I protect myself as a cosigner?
What is cosigning a loan?
Cosigning is an option that lenders will often allow for a variety of loans. It is considered a type of joint credit that is associated with either a cosigner or co-borrowing agreement. Cosigning can be a benefit for borrowers with low income or minimal credit history.
Who is a co-signer on a loan?
A co-signer is someone who agrees to take on the financial responsibility of the primary borrower’s loan if they can no longer make payments. Co-signers can be family members, friends, spouses or parent s. Co-signing on a loan isn’t just a character reference – it’s a legally binding contract.
Can a cosigner contribute to a loan if I don’t cosign?
Lenders use the lowest credit score between you and your cosigner to determine what interest rate they’ll offer you. You don’t have enough down payment funds. Your cosigner is allowed to contribute towards your down payment, but in most cases they could do so even without cosigning the loan. Cosigner vs co-borrower: What’s the difference?
Can a lender release a cosigner?
If you ask, the lender might include an option in the loan agreement to release you as the cosigner. The lender and the main borrower must both agree to remove you from the loan and release you from responsibility to pay. The lender isn’t likely to release you because it would increase the risk for them.
Does co-signing a loan build credit?
When someone has a thin credit history or is rebuilding their credit, having a co-signer with a good score and an established credit history is powerful. Not all personal loan lenders allow co-signers, so it’s worth checking before you apply. » MORE: Best personal loans
Can a co-signer sign a home loan?
Let’s take a look at the limitations for both types of loans. If you’re looking to apply for a conventional loan with a co-signer, they’ll need to sign the home loan and agree to repay the mortgage if the primary occupant defaults. However, the co-signer doesn’t need to be on the home’s title.