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A cosigner with good credit can help push a marginal loan application over the top. By agreeing to share responsibility for the debt, a cosigner helps lower the risk for the lender and improve chances of approval for the borrower.
Cosigning a loan is a great way to help someone you care about, but it can also put your credit and finances at risk. If you're thinking about cosigning, review the pros and cons first. By fully understanding what you're signing up for, you may avoid potential problems down the road.
What Is a Cosigner?
A cosigner adds their good credit and income to a loan application to help a new or marginal borrower qualify. Cosigners agree to bear equal responsibility for the loan and to make payments if the borrower can't or won't, which decreases risk for the lender.
Cosigning a loan means the debt will appear on your credit report. If the borrower makes late payments or defaults, your credit history and credit scores could be affected. You may also be on the hook for late payment fees. You won't receive any proceeds from the loan or credit line, and you won't have an ownership stake in any property purchased with the loan.
Learn more: What Credit Score Does a Cosigner Need?
Pros of Cosigning a Loan
The potential pros of cosigning a loan are short but significant. Here's the best case for becoming a cosigner, in spite of any potential problems.
You're Helping Someone in Need
Helping someone you care about qualify for a needed loan is the single best reason to consider cosigning. As a cosigner, you can help your child or grandchild finance their first home, qualify for student loans or buy a car. Cosigning a personal loan may help a friend consolidate debt.
Under the right circumstances, cosigning lets you help someone you care about secure and manage loans or credit. Cosigning may also help the borrower get a more favorable interest rate. For young people just starting out or anyone who's trying to start over, that help can be a valuable first step toward financial independence.
It Could Help Improve Your Credit
More incidentally, cosigned debt can have a positive effect on your credit, as long as the loan is managed well. On-time payments contribute to your payment history and the presence of the loan could improve your credit mix, which reflects positively on your credit.
Cons of Cosigning a Loan
Cosigning a loan can also have negative implications for your credit and borrowing power, even when payments are made on time. Additionally, if you run into trouble, your relationship with your friend or family member can suffer.
Here's a quick rundown of potential issues for cosigners to consider.
It May Hurt Your Credit
If the borrower has difficulty paying the loan, those issues may be reflected on your credit report, including late payments, collections and repossessions. Any of these can lower your credit scores, and can stay on your credit report for as long as seven years.
Tip: You may want to consider free credit monitoring, which will alert you to changes in your credit file when they happen. Minding your credit report is another way to keep track of on-time payments, on your accounts as well as any loans you've cosigned.
You May Limit Your Borrowing Power
Cosigning can affect your debt-to-income ratio (DTI), a comparison of your earnings versus monthly debts that lenders consider when you apply for a loan or credit. Monthly payments for loans you cosign are included in this calculation, even if you're not the one making payments.
You May Have Trouble Opting Out
Removing yourself from a cosigned loan can be difficult. Lenders may need to requalify the borrower using their own credit in order to remove your name from the loan. Alternatively, the borrower may have to refinance, sell the property or pay off the loan to extricate you from the arrangement.
You May End Up Paying the Loan Yourself
If the borrower doesn't repay the loan, you are responsible for repaying it. Depending on the loan amount and how much has already been repaid, this could mean taking on an additional mortgage payment every month—or assuming a mortgage-sized debt. You may also be responsible for late fees, interest or attorney fees, if they apply.
You May Strain Your Relationship
Having to take over monthly loan payments or assume a large debt puts an obvious strain on a relationship. But even if problems never come to this, cosigning may add a level of dependency that's problematic. You may (justifiably) worry about the borrower's financial status and whether they're paying their bills on time. If your loved one misses a payment by mistake or runs into financial difficulty, you may feel angry or betrayed, which will add to the stress of an already tense situation.
When to Consider Cosigning a Loan
Consider the contractual pros and cons of cosigning, but also your ability to take on additional financial responsibility and risk. Weigh the strength of your relationship with the borrower and how comfortable you are carrying a shared responsibility for debt.
Before signing onto any loan or agreement, make sure you've covered the following bases.
You Have Complete Trust in the Borrower
Lenders use credit scores, credit history and other information from a borrower's 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 regular payments and pay off the loan.
You Can Build in Transparency
For your reference, read and retain copies of any loan or credit card agreement or contract. You may want to request online access, so you can see what's going on with the account at any time. If possible, add yourself to notifications so you receive word from the lender if there are problems paying the account.
You Have Contingency Plans
What happens if the borrower can't make a payment on time? You may want to step in and help with payments before they're past due to avoid any consequences to your credit history. What happens if the borrower has a major financial setback and can't continue making payments over the long term? Talking through contingencies may be easier now, when the situation isn't emotionally charged.
Finally, what happens if you need to bow out of the arrangement? Find out what your options are before you sign, so everyone knows what to expect.
You Can Afford to Pay the Loan Yourself if Needed
Suppose you're forced to repay a loan yourself. Can you afford the payments? Will it cause genuine hardship? In addition to discussing these risks with the borrower, think them through on your own. Cosigning a loan can be a real help to credit-challenged loved ones, but you shouldn't have to put your financial health at risk.
Alternatives to Cosigning a Loan
Cosigning a loan isn't the only option. If you're worried about taking responsibility for someone else's debt, here are some alternatives to consider:
- Make a cash gift: Although a cash gift will definitely (and not just potentially) cost you money, it's also a simple transaction. A borrower can use cash to make a purchase outright, increase their down payment (and shrink their loan size) or create an emergency fund they can use instead of a credit card.
- Offer a family loan: Instead of involving an outside lender, make a loan from your own funds. Lending to or borrowing from family or friends can be fraught, so consider drawing up a formal loan agreement to make the process more official.
- Borrow the money yourself: Taking out a loan in your own name puts the responsibility for repayment squarely on your shoulders. However, you won't have to worry that the loan is going unpaid without your knowledge.
- Provide collateral to back their loan: A borrower who doesn't qualify for an unsecured loan may be able to secure a loan with collateral. If you can, offer your property or funds as security on the loan. Though your collateral will still be at risk, you won't have the same credit implications you would on a cosigned loan.
Frequently Asked Questions
How Does Being a Cosigner Affect Your Credit?
When you cosign a loan or credit card account, the debt appears on your credit report, even if you aren't the person collecting the loan proceeds or making the payments.
- A hard credit inquiry and the appearance of a new account may cause a temporary drop in your credit scores. New accounts are one of five common factors that help determine your FICO® Score☉ Θ.
- Late payments may damage your credit scores. Payments that are 30 days or more past due may appear on your credit report and affect your credit scores.
- Collections and defaults also appear on your credit report. These negative items may stay on your credit report for up to seven years.
How Long Is the Cosigner Responsible for the Loan?
A cosigner is responsible until the loan is paid off, the borrower refinances or the lender formally releases them. Before you cosign a loan, ask about your options. Find out from the lender whether a cosigner release will be possible and under what terms. Also talk to the borrower about potential exit strategies. For example, you might agree that they'll sell the home (or car) or refinance it in their own name after a certain period of time.
Can You Remove Yourself as a Cosigner?
You may not be able to walk away from a cosigning arrangement whenever you want. Unless the loan agreement has provisions for releasing a cosigner, it can be difficult to extricate yourself without asking the borrower to refinance their loan or apply for a new credit card using only their own credit.
The Bottom Line
Weigh the pros and cons carefully before you agree to cosign any loan. You should feel confident in the borrower's ability to repay and have open lines of communication with them throughout the repayment process. Consider that helping someone take out a loan they can't afford or take on a responsibility they aren't ready to meet isn't really helping. Also, make sure you aren't putting yourself in financial jeopardy.
If you decide to cosign, give yourself some credit. By extending a hand and agreeing to vouch for your friend or family member, you're giving them the opportunity to build their credit as well as their financial future. If you're thinking about cosigning a loan, you may want to check your credit reports and FICO® Score beforehand, so you know where your credit stands from the start.