If your friends or family ask you to become a co-signer, think about the consequences before saying yes. Co-signing loans come at a risk.
In this article, we’ll explain what you need to know about the role of a co-signer, the risks, and the questions you need to consider before signing on.
I | What is a Co-signing?
When you co-sign a loan, you legally accept responsibility for repaying the borrower’s debt if they default. You are the lender’s security that they will recoup their investment.
A co-signer is not the same as a co-applicant or co-borrower. You are not applying for the use of the money, and you don’t have any claims on it. All you’re doing is acting as backup repayment.
On top of taking responsibility for the loaned sum, the lender may also require you to pay late fees, interests, and collection fees if the borrower defaults.
While you want to help a friend or loved one, assume the position with an understanding and acceptance of the risks involved.
II | Why Someone May Need a Co-Signer
When a borrower cannot secure a loan on their own, it’s usually because:
- They do not have a credit history. For example, a young adult seeking a student loan for college or university. First-time borrowers won’t have records for a credit report.
- Their credit score is low and doesn’t qualify them for the loan they want. The poor scoring may be because of a high DTI (debt-to-income ratio), previous delinquent payments, a history of bankruptcy, or similar infractions on their record.
The borrower may qualify for a loan, but the interest rate is too high.
In these cases, lenders suggest the addition of a co-signer. Someone with a good credit score, credit history, and a higher income level will strengthen the loan application. With a co-signer matching this description, the applicant can qualify for a loan and more favorable rates.
Mortgages, auto loans, credit cards, and private student loans may require a creditworthy co-signer.
III | The Risks of Co-Signing a Loan
1. As a co-signer, you’re responsible for repaying the loan.
When you co-sign for a loan, this is what you’re saying: I am accepting full responsibility for the repayment of the loan should the primary borrower default.
Have this at the front of your mind. You’re on the hook for the outstanding money.
Suppose the borrower stops paying the monthly installments for any reason, and there isn’t another agreed-upon provision between them and the lender. In that case, the responsibility falls on you.
Ensure you receive a copy of the loan documents and understand all the terms and penalties involved. What are your full responsibilities and the possible repercussions of negative credit events.
Request duplicate statements to be sent to you so you can monitor the status of the debt payments.
2. Co-signing puts your credit at risk.
Accepting the responsibility of repayment means accepting the debt. All the debts you take on reflect in your credit score.
Co-signing for someone else may affect your borrowing abilities in the future. If you have plans to take out a car loan, mortgage, insurance, or credit card, this information shows up in your credit history check.
Lenders weigh your debts against your income when deciding on your loan application. Do you have the extra cash flow to offset the debt? Your lender will ask for verification your income can handle the addition of another loan.
The loan activity of the primary borrower is a shared burden. Any missed payments or late payments on the loan you co-signed paint you in a poor light.
Outside of delinquent behaviors, your name’s mere appearance on a loan affects your score.
It’s a calculated risk tying your finances with someone else. Before becoming a co-signer, evaluate your financial standings and the plans you have for the future. Determine how co-signing will handicap your chances and what you can do to decrease the negative effects.
3. Co-signing puts your relationships at risk.
Money causes a lot of relationship issues. No matter the type of relationship, once money is a central issue, things can get sticky. When you take on the shared responsibilities, your relationship with the borrower is on the line.
Let’s look at some statistics from a 2016 Princeton Survey Research Associates International survey.
- 38% of co-signers surveyed stated they ended up paying some or all of the outstanding balance because the borrower defaulted on the loan.
- 28% experienced a dip in their credit score because of late and missed payments.
- 26% reported problems in their personal relationships because of the negative experience of being a co-signer.
4. You can lose your personal property and face lawsuits.
If you present any of your property as collateral for the loan, you can lose them. If the borrower defaults and you can’t cover the required payments, then the lender will confiscate the assets you named as collateral.
If you’re co-signing for a secured loan, these collaterals may include your car, house, or other valuable items like jewelry.
Not making the payments may also lead to a lawsuit.
IV | Questions to Consider Before Co-Signing a Loan
Do you trust the other person?
Despite the urge you feel to help a friend or relative, co-signing is something like a business decision. It requires a logical approach with so much of your financial flexibility on the line. All infractions from the borrower reflect on your credit report.
Only co-sign a loan with someone you trust without reservations.
Can you afford the risks?
Can you afford the monthly payments of the loan you co-signed? How far in the red would you be if you lost the entire outstanding balance from your savings?
This risk extends beyond the present into the future. What if the borrower falls into tough times a year or two from now? Can you step in and cover the loan payments?
Is there another way you can help without risking your financial standing?
Perhaps the person asking for a co-signer is a close relative or friend you want to help. But, in the back of your mind, you’re uneasy with the delicate situation it puts you in. If you’re unable to say no, consider co-signing alternatives.
Perhaps you can gift a portion of the money.
Do you reap any benefits from the risk?
The benefits may outweigh the risks if you co-sign your child’s student loan. If you’re helping a friend with their credit card debt or buying a car outside their comfortable means, then reconsider. For you and your friend as well.
Accumulating unnecessary debt is never a good idea. And purchasing a car or house within your budget is a wise financial decision. It might be a red flag that they will overextend and require your good credit as a blanket.
V | Co-Signer Release and How it Works
You can’t opt out of the position as co-signer on a whim. Nor can you remove your name because you’re experiencing tough times or realize in hindsight being a co-signer bombed your chances of borrowing yourself.
Ask about the availability of a co-signer release. A co-signer release allows for the removal of your name after the primary borrower meets certain milestones.
These milestones can include:
- Consecutive on-time payments over a period usually spanning two years
- The borrower achieves a specified credit score
Once the borrower reaches the two years or score milestone, request the release.
The release can also work in the borrower’s favor. If you pass away during the loan’s lifetime or file for bankruptcy, this will trigger an automatic default. The lender will require the outstanding balance paid in full if this occurs.
Not all lenders offer releases. They use you, the co-signer, as insurance for their investment. They won’t increase the risk of a loss on their part easily.
All the same, ask for a co-signer release. With one, you have added peace of mind. You won’t have the debt stuck on your record for longer than two years if the borrower acts responsibly with their payments and strengthens their credit.
Conclusion
Co-signing a loan is as risky as being the primary borrower. Don’t accept the position without careful examination of the risks. Your future and financial plans are also on the line.
Make sure you can handle the risks as if you were the primary borrower on record.
- How much do you trust the other person to pay the loan on time and not default or miss payments?
- Can you afford the risks of repayment if the borrower defaults?
- Is there another way you can help without risking your financial plans?
Consider the pros and cons. The borrower’s habits can sully your credit reputation and lead to messy relationships.
