Co-Signing a Loan: Risks and Benefits
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Co-signing a loan The Advantages and Risks
Co-signing a loan may aid the borrower in qualifying however it can hurt your credit score and overall finances.
Last updated on Dec 16, 2022
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You may be required to co-sign a loan by your spouse, child or family member, particularly if you’re credit score is higher than theirs.
However, what may sound like a noble act helping someone else get money for a new house or tuition for college — could result in consequences you may not expect.
What is a co-signer?
A co-signer is someone who includes their name, credit score and financial details to the applicant’s loan application, and agrees to be legally responsible to the loan amount as well as any additional charges, should the borrower be unable to pay.
A majority of people need or want co-signers because they don’t qualify for the loan on their own. If you have a solid financial history, co-signing people with a lower credit score or a weak credit profile can improve the chances of getting a loan or obtaining the lowest interest rate.
In contrast to a situation where two borrowers have equal access to the loan when they co-sign the loan co-signer is granted no right to the money even though they could be in the position of having to pay.
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Risks of co-signing for a loan
Co-signing a loan puts you in a uniquely risky situation. These are the potential risks to consider as well as ways you can safeguard your finances as well as your relationship if you choose to sign a co-signing.
1. You are accountable for the entire loan amount
This is the biggest risk when co-signing for a loan is not just about lending your good credit reputation to help another person. It’s a pledge to fulfill the loan when they’re unable to pay them, which includes any late fees or collection costs.
Before you sign a co-signing contract, look at your own finances to ensure you can cover the loan repayments in the event that the primary borrower cannot.
2. Your credit is at risk
When you co-sign a loan, both the loan as well as the history of your payment show up on your credit reports as well as that of the credit report of the borrower.
In the short term you’ll experience a brief impact on your score on credit, says Bruce McClary, spokesperson for the National Foundation for Credit Counseling. The lender’s hard check of your credit prior to accepting the loan can affect your credit score, he says and could lead to an growth in your debt load.
The most important thing to remember is any missed payment by the borrower can adversely affect your credit score. Since your payment history can be a factor in the a misstep here can wreck your credit.
3. Your access to credit may be affected
The long-term risk of co-signing the loan for a loved one is that you may not be able to get credit when you need it. A potential creditor may factor in the co-signed loan to calculate the total amount of debt and could decide that it’s not risky to offer you additional credit.
McClary recommends checking your credit report frequently after signing a co-signing agreement to monitor your finances.
4. You could be accused of being sued by the lender.
In certain states, when the lender fails to receive payments, it may try collecting money from the co-signer before proceeding to pursue the primary borrower, according to the Federal Trade Commission.
To get to that stage it is likely that the borrower have missed several payments, and the debt may already be affecting your credit. The lender is likely to think about legal action when the debt is between 90 and 180 days past due.
If the worst happens and you’re sued due to not paying, you’re liable as the co-signer for the entire cost including attorney’s charges.
5. Your relationship may be damaged
The borrower might begin making timely, full payments toward their loan or credit card with great intentions. But financial and personal situations alter.
Children who run into trouble in the payment of a credit card that is co-signed or a car loan could hide the problem to their parent until the situation worsens, ruining trust within the family.
Couples going through a divorce may have to deal the financial ramifications of a co-signed vehicle or mortgage, says Urmi Mukherjee who is a certified financial counselor at Apprisen, a non-profit financial counseling agency. In such cases it could be difficult to convince one spouse to pay their share, especially if the spouse has left the home or sold the car.
6. The process of removing yourself from co-signing isn’t an easy task.
If there are issues, removing yourself as the co-signer is not always an easy process.
A lender who allows a co-signer to be let out of a loan can need to conduct a credit assessment of the main borrower to determine if they can pay the loan on their own. Students loans as well as personal loans generally require a specific amount of timely payments before the lender will review the primary borrower to see if they can make payments by themselves.
Benefits of co-signing a loan
The benefits of co-signing an loan for someone is obvious You can assist them get student loans, a credit card or other financial product that they might not obtain on their own, or save them the cost of interest with a lower interest rate.
If someone is just beginning to build credit or is rebuilding their financial situation, having a co-signer with a high credit score and a good credit history is powerful.
Some online personal loan lenders permit co-signers so make sure to check before you apply.
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Does co-signing a loan build credit?
A co-signer can help to build your credit in these ways:
When the payments are paid on time, it adds to your payment history. However, if you have an excellent score and established credit, the effect may be small compared with the danger to your score if the borrower doesn’t pay.
There’s a possibility of a slight benefit if your credit mix improves. It’s beneficial to keep both installment loans (with low payments) and revolving accounts (like credit card).
The person you co-signed for can build their credit in these ways:
It can aid them in obtaining credit that they would otherwise not qualify for, as well as boosting a thin credit file.
The ability to make timely payments on the account build an impressive payment history.
How to safeguard your credit score if you co-sign for a loan
Before you co-sign, ask whether the lending institution knows what their rights and obligations are and how you’ll be informed in the event of a payment issue.
In addition, solicit the primary borrower to grant access to your loan account, so that you can track payments, says Byrke Sestok who is a certified financial planner at the New York-based Rightirement Wealth Partners.
«It’s not an issue with trust — issues do occur,» Sestok says. «If you find out within the initial month somebody is experiencing difficulty paying back the loanand not being able to pay back the loan do something about it.»
To prepare for these situations, establish an arrangement between co-signer and borrower upfront and in writing that spells out expectations for each person, McClary says. Your private agreement will help in settling mismatched expectations, he adds.
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Alternatives to co-signing on a loan
If you’re not willing to co-sign a loan you can choose other options for the borrower:
You can try a family loan If the applicant was hoping to have an individual from their family sign for them, they may decide to go with a different. A family loan does not require any third-party lenders, which means there’s no formal application or approval process, but it must be accompanied by an unsigned, notarized contract between both parties summarizing the terms. Family loans can help borrowers get cheaper loans and avoid lenders who are predatory, but they still expose the finances of a person else to danger should the person who is borrowing be unable to repay the loan.
Offer collateral: A borrower might be able to offer large-ticket items such as a car or a savings account as collateral on a loan. This is called collateral. It comes with a certain risk. If the borrower fails to pay the loan the loan, they’ll lose whatever asset they’re pledging.
: There are online lenders who specialize in applicants who have bad credit. These lenders have looser requirements than banks and they will consider other factors other than credit score. However, interest rates for online lenders can be quite high in the event of bad credit, with annual percentage rates typically above 20 percent.
Author bio Jackie Veling covers personal loans for NerdWallet.
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