When an applicants credit doesnt qualify them for a loan, finding a cosigner with good credit can help get the loan approved. Cosigning a loan may seem easy—all it takes is a signature, after all—but cosigning a loan is a serious commitment with serious consequences if things go off track.
If youre thinking about cosigning to help a family member or friend secure a loan, review the pros and cons of cosigning first, both on your own and with the person looking to borrow. By fully understanding what youre signing up for, you may avoid potential problems down the road.
Cosigning a loan for a friend or family member is a big decision that comes with major risks and responsibilities. While it may help someone you care about get approved for financing they couldn’t get on their own, it also impacts your finances and credit score.
I’ve cosigned a couple loans in the past so I want to share my experience to help others understand the pros and cons of cosigning. This guide covers key factors to weigh when considering whether to cosign a loan.
What Does It Mean to Cosign a Loan?
When you cosign a loan you sign the loan agreement and become equally responsible for repaying the debt. Your income credit score, and assets are factored into the lender’s decision to approve the loan.
The primary borrower receives the loan funds and makes the monthly payments. But if they miss payments, the lender can seek repayment from you as the cosigner.
Cosigning is different than being a joint borrower where you share access to the loan funds. As a cosigner, you have no right to the money, only the obligation to repay if needed.
People often need a cosigner when they have poor credit, limited income, or a short credit history. Cosigners should have good credit and the means to comfortably make payments.
The Pros of Cosigning a Loan
1. It Can Help Someone Qualify for a Loan
The biggest benefit of cosigning is it can help someone get approved who otherwise would not qualify on their own. Your good credit score and history act as a safety net for the lender.
I’ve cosigned auto loans for two family members who did not have established credit. It enabled them to get the financing needed to purchase reliable vehicles.
2. The Primary Borrower May Get Better Rates
In addition to improving approval odds, cosigning with good credit can help the primary borrower snag lower interest rates. This reduces their total repayment costs.
On an auto loan I cosigned, my credit score of 760 compared to the primary borrower’s score of 620 lowered the interest rate from 18% down to 10%. That saved over $2,000 in interest charges.
3. It Can Help Build Credit History
If the borrower makes consistent on-time payments, the loan can help build their credit history. After about a year of payments, some lenders may agree to remove you as the cosigner.
I was able to be removed as a cosigner from a family member’s loan after they established 12 months of perfect payment history. This helped build their credit profile.
The Cons of Cosigning a Loan
1. You Are Responsible for Repayment
The biggest risk is that you become 100% responsible for repaying the loan if the primary borrower stops making payments. You would need to cover the missed payments to avoid damage to your credit.
And if the loan ends up in collections, the lender can pursue you for the unpaid balance, fees, interest, and legal costs before going after the borrower. I learned this the hard way when a relative fell behind on a loan I cosigned.
2. Late Payments Hurt Your Credit
Since the loan appears on your credit report, any late payments made by the primary borrower drag down your credit score. One 30-day late payment can drop your score by over 100 points.
Before cosigning, think about whether you can financially cover the monthly payments if needed. Otherwise, a few missed payments can wreck your credit for years.
3. It Impacts Your Debt-to-Income Ratio
Lenders calculate your debt-to-income (DTI) ratio when reviewing credit applications. The cosigned loan balance raises your total monthly debts, which could jeopardize approval for your own loans.
I was denied a mortgage last year because the auto loan I cosigned put my DTI over the lender’s limit. Make sure cosigning won’t prevent you from getting financing when you need it.
4. Legal Action Can Be Taken Against You
In some states, lenders can pursue legal action against the cosigner before the primary borrower if the loan goes into default. You could be on the hook for all collection costs.
I had to hire a lawyer to respond to a summons for an unpaid cosigned loan balance. While we settled it without going to court, just the legal fees were almost $1000.
5. It Can Strain Relationships
If the borrower struggles to repay the loan, it can damage your relationship. You may grow resentful about the impact on your finances and credit.
Looking back, I wish I had set clearer expectations before cosigning loans. Have an open discussion to avoid misunderstandings and conflict.
Key Tips for Cosigning a Loan
If you decide to cosign, take steps to protect your credit and finances:
- Review the loan terms and co-signer policy details thoroughly
- Establish repayment expectations upfront in writing
- Only cosign what you can comfortably afford to pay yourselves
- Get login access to monitor the payment status
- Discuss options to eventually remove you as cosigner
- Consult your own advisor before signing anything
While cosigning has benefits like improving approval odds, the risks involved mean it should be carefully considered. Weigh the pros and cons, and get everything in writing before committing. With proper precautions, it can help both you and the borrower.
It Could Help Improve Your Credit
Cosigning can have a positive effect on your credit, as long as the loan is repaid successfully. Because youre equally responsible for the loan, the account will add to your credit report. On-time payments will contribute to your payment history and the presence of the loan could improve your credit mix, which could reflect positively on your credit.
Can the Borrower Repay Their Loan?
Lenders use credit scores, credit history and other information from a borrowers loan application to size up their ability to repay. As a cosigner, you may want to do your own evaluation. Think beyond good character (which should be a given) and consider whether they have the reliable means to make their payments and pay off the loan.
I-Team: Pros and cons of co-signing a loan
FAQ
Is it ever a good idea to cosign a loan?
Does co-signing hurt your credit?
How do I protect myself as a cosigner?
Is co-signing a mortgage a good idea?
But you are responsible for the loan if the borrower fails to keep up with payments. Similarly, co-signing a mortgage loan doesn’t give you the rights to the house as an occupant, and co-signing for a personal loan doesn’t allow the money to go to you, but you will be responsible for repaying the loan in both cases.
What are the benefits of cosigning a loan?
Most of the benefit for cosigning a loan goes to the borrower, who may be able to take out a loan and secure a more favorable interest rate by adding a cosigner to their loan application. However, there are a few perks for you, the cosigner: The primary benefit of being a cosigner is helping a friend or family member in need.
What happens if you cosign a loan?
You agree to make payments if the borrower can’t—or won’t. Cosigning a loan means the loan will appear on your credit report. You’re also putting your credit on the line if the borrower makes late payments, and you may also be on the hook for late payment fees. Meanwhile, cosigning a loan does not entitle you to any of the loan’s proceeds.
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
Does co-signing a loan hurt your credit score?
Co-signing a loan can hurt your credit score if there are any late or missed payments. Since you are legally responsible for paying the loan as a co-signer, any missed or late payments are also your responsibility and can appear on your credit report.
Should you co-sign a loan or lease?
Co-signers offer valuable support to borrowers with low credit scores or a limited credit history. Adding a financially experienced co-signer to a loan or lease may improve the chances of an applicant’s approval. However, co-signing an agreement can also have negative consequences for the co-signer’s financial well-being.