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Co-signing a loan: pros and cons

Should you sign? Know the risks first

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Written by Sandy Baker
Edited by Cassidy McCants

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    Making the decision to co-sign a loan can feel good. It may mean you’re helping a family member or friend get funds they need — but it also creates risk for you, so it’s worth taking a closer look at this process and what it means before you decide to go forward with it.

    What is a co-signer?

    A co-signer is someone who agrees to provide financial backup to a friend or loved one taking out a loan. Having a co-signer helps borrowers with lower credit boost their ability to obtain a loan — as long as the co-signer has a stronger financial profile. However, co-signing can be risky — you take on the responsibility of the debt if the initial borrower fails to make payments on time.

    In the case of an unsecured personal loan (without any type of collateral), co-signing provides the lender some type of guarantee that the loan will be repaid if the primary borrower defaults.

    How does co-signing a loan work?

    When you co-sign a loan, you are just as responsible for paying back the loan as the primary borrower. If the primary borrower misses a payment or fails to repay the loan, the lender can take action to collect the money from you. As the co-signer, you are essentially guaranteeing the loan.

    For example: Let’s say your son or daughter is hoping to consolidate their debt with an unsecured loan, but their credit score doesn’t meet a lender’s eligibility standards. They could ask you — someone with excellent or good credit — to become a co-signer and help them qualify. Going forward, if your child is unable to meet their repayment obligations, you are legally responsible for stepping in to repay the lender.

    Pros and cons of co-signing a loan

    Is co-signing the right move for you? What about for your loved one or friend? Before you make a decision, consider these benefits and drawbacks.

    Co-signing benefits

    The biggest benefit to co-signing is that it helps someone you know qualify for a loan. The loan might be an auto loan for buying a car, a student loan for tuition or a personal loan, which can be used for paying down debt or making home improvements. Having a co-signer can help the primary borrower build credit and financial confidence.

    In some situations, you may see a boost in your own credit score if payments are made on time. As a general rule, as long as the debt is repaid properly, there should be no harm to you financially.

    Co-signing drawbacks

    The most significant downside of co-signing is you’ll be responsible for repaying the loan should your loved one or friend fail to do so. This could add a financial burden to your budget — and it could put your assets at risk if you don’t pay back the debt as agreed.

    The co-signed loan could also show up on your credit report and increase the amount you owe, which makes up 30% of your FICO credit score. Your debt-to-income (DTI) ratio will also increase, which may affect your ability to qualify for a loan yourself.

    In a worst-case scenario, if the primary borrower defaults, the lender could use collection methods against you — including a lawsuit — to get its funds back. Apart from financial matters, it’s also important to consider how your relationship with the borrower could be affected if they fail to repay the loan.

    FAQ

    How can a co-signer get out of the loan?

    One way to be removed as a co-signer is to have the debt refinanced into a new loan without the co-signer’s name. Other potential options include requesting a “loan release” from a lender, moving the debt to a balance transfer credit card or selling the asset connected to the loan and using the funds you receive to repay the debt (on a secured loan).

    What should you do if you can’t find a co-signer?

    If a lender requires a co-signer for you to qualify and you can’t find one, you can try searching for other lenders willing to work with you.

    Otherwise, you may need to increase your credit score or income to meet lenders’ requirements. For some potential borrowers, like one of our reviewers from Florida, it’s worth taking the time to build credit to meet eligibility criteria so a co-signer isn’t necessary.

    Do you build credit if you have a co-signer?

    As long as the lender reports the loan to the credit bureaus, a loan with a co-signer can help you build credit. Just be sure to make payments on time every month and work to pay down your debt according to the terms of the loan. Over time, you may be able to build your credit enough to obtain a new loan without a co-signer.

    Does co-signing affect your ability to borrow?

    Co-signing a loan could affect your credit score, which in turn may affect your ability to qualify for a loan. Co-signing for a loan will produce a hard inquiry on your credit report and increasethe total amount you owe, which may lower your score.

    Additionally, any late payments or a default will cause your score to drop. The extra monthly payment adds to your debt, which increases your DTI ratio — another factor lenders consider when you apply for a loan.

    Just because you co-sign a loan doesn’t mean it will negatively affect your ability to borrow, though. As long as the primary borrower makes payments on time, your credit score will recover and might even increase — and if you have sufficient income, your DTI will remain in a qualifying range for a loan.

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      Bottom line: Should you co-sign a loan?

      Does it make sense for you to co-sign a loan? This is very much a personal decision based on your particular situation. If you’re financially capable of paying off the debt if the other party fails to make payments, then it may be a good idea — and tremendously helpful to the primary borrower.

      However, because there is a risk of your loved one or friend defaulting, you need to consider the potential consequences, including both the financial impact and the rift it could cause.

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