Suppose someone you know needs a loan. It might be a spouse, a parent, a child, or a friend.
But their application for financing is denied. Or the terms they’re offered aren’t nearly as good as they’d hoped.
Typically, the reason lies with some weakness in your friend’s application. It could be a low credit score, insufficient credit history, a high debt-to-income ratio, low income, variable income, or some other detail. Whatever it is, the lender sees the applicant as a financial risk.
But a cosigner might offer your friend a leg up.
A cosigner is someone who adds their name to a loan. So, as a cosigner, you assume certain financial responsibilities and risks. But your friend gets the benefit of your strong financial history backing up their application.
If you have good credit and other traits appealing to lenders, you might choose to cosign a loan alongside your friend. In doing that, you increase that person’s odds of qualifying for a loan and getting favorable terms.
At first glance, cosigning a loan seems like a win-win. Your friend gets the financing they need, and you get the satisfaction of helping a loved one through a tough time.
But cosigning a loan has very real consequences for the cosigner. And it’s essential that you know and understand those implications before you commit yourself to the loan.
When you act as a cosigner, the borrower is no longer the only person responsible for repaying the loan. You are equally liable.
So, if the borrower doesn’t make the necessary payments, it’s up to you to cover them. And the lender can pursue you for 100% of missed payments — even though you didn’t get a cent of the money that was borrowed.
Additionally, you’ll see that the loan you cosign appears on your credit report alongside your own loans and lines of credit. Consistently prompt payments — by your friend or by you — can be a plus for your credit history.
But missed payments on that cosigned loan will be a black mark on your report. And they’d likely damage your credit score as well.
There are several potential pitfalls you might face as a cosigner. So, you’ll want to assess your willingness to accept these risks before signing:
1. Your credit score
Since the loan is in your name alongside the borrower’s, late and missed payments appear as negative events on your credit history report. Even one reported problem with payment can have a significant, negative impact on your credit score.
2. Liability for money owed
As a cosigner, you have the same liability for repaying the loan that the borrower does — even though they got the cash and you didn’t.
3. Limitations on future financing
Even though you don’t receive the financial benefit of the loan, the loan amount is considered part of your debt when you apply for credit. The amount owed increases your credit utilization, which bumps up your debt-to-income ratio and could negatively affect your credit score.
As a result, cosigning a loan might actually make it harder for you to get credit or receive the best loan terms before the cosigned loan is closed.
4. No way out
As a general rule, you’re stuck once you cosign a loan — even if you want to undo your commitment later. Usually, you’ll need the borrower to close the loan to free yourself as a cosigner.
To do that, your friend (or you) can pay off the balance. Or the borrower can refinance the loan by themselves or with a different cosigner on the new loan.
5. Relationship strain
Even if your friend is a model for borrowers everywhere, being a cosigner can fundamentally change your relationship. Your friend is indebted to you. They’re benefitting from your financial risk. And that can lead to resentment on both sides.
The problem worsens if the borrower starts missing payments. You might find yourself paying out of your own pocket or suffering credit damage. And you may need to have some difficult conversations with your friend as a result.
Should you cosign a loan?
There are plenty of financial and personal risks that go along with cosigning a loan. In many cases then, the best choice is declining to act as a cosigner.
Fortunately, you can still help your friend in need without compromising your own financial health.
Often, the person asking you to cosign doesn’t fully realize just how much is at stake. So, you can share what you know about the implications for the borrower and the cosigner.
And many people also don’t realize how many options they have for financing beyond getting a cosigner. Help them identify reputable lenders for bad credit loans and consider all the ways they can borrow, given their credit history.
If you do decide to cosign a loan, you can take steps to limit your risk and protect yourself:
1. Talk openly about money.
You’re entering into a financial arrangement, so you want transparency and accountability. Ask your friend about their income, their job security, and how they’ll ensure prompt and full payment each month.
2. Clarify expectations.
Understanding the risks involved, what do you need from the borrower to feel comfortable cosigning? Maybe you want monthly check-ins, proof of payment, advanced notice if they won’t be able to pay, etc. Clearly state your expectations and have the borrower commit to meeting them.
3. Verify payments.
Remember: Late payments can impact your credit. So, even if you trust the borrower completely, protect yourself from accidental oversights by tracking loan payments.
You might ask for your own login to view the account. Or have them forward you an E-mail confirmation of payment every month.
4. Keep a reserve of cash on hand.
If a payment is late, you’ll want the ability to cover it yourself. Save at least the amount needed for one monthly payment in a separate savings account. That way, you can pay the bill easily without going into debt yourself.
5. Keep a close eye on your own credit.
Check your credit history report regularly to see how the loan appears on it. Does it accurately reflect the loan details and the payment history? File a dispute right away if you spot an error in how payments are reported.
And keep tabs on your credit score. You’ll want to know how the loan impacts it over time — particularly if you’re planning to apply for new credit yourself.
Cosigning a loan can offer great advantages to someone who can’t easily qualify for a loan. But the cosigner must understand what they’re taking on. Only in knowing the risks and obstacles can you take the steps you need to protect yourself and your finances.
Note: Co-sign loans are not currently offered on the Personify platform.