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Sometimes having a co-signer can be the key to loan approval. While the primary signer should be responsible for repaying the loan, a co-signer takes on the responsibility of repaying the debt if the loan goes into default.
This financial risk makes co-signing a loan a serious commitment that can have long-lasting consequences for both parties involved. Here’s what you need to know before agreeing to be a co-signer.
Key insights
When you co-sign a loan, it will appear on your credit report and can impact your credit score if the primary borrower misses payments or defaults on the loan.
Co-signing a loan can put a strain on your relationship with the primary borrower, especially if they struggle to make payments or default on the loan.
Co-signing a loan can be a good option for helping someone establish credit, such as a young person or someone with no credit history.
What is a co-signer?
A co-signer is someone who agrees to provide financial backup to someone else (usually a friend or loved one) taking out a loan.
“Adding a co-signer is usually most helpful for original borrowers who have a low credit score or short credit history,” said Kendall Clayborne, a certified financial planner at SoFi. “The co-signer is only responsible for making payments if the original borrower is unable to. It is important to note that if a payment is missed or late, it affects both the borrower and co-signer’s credit scores.”
In the case of an unsecured personal loan (without any type of collateral), co-signing provides the lender with more certainty that the loan will still be repaid if the primary borrower defaults.
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 a family member 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 they are unable to meet their repayment obligations, you are legally responsible for stepping in to repay the lender. If you don’t, both your and the primary borrower’s credit scores will be negatively affected.
Co-signing a loan can benefit your family member or friend because it allows them to increase their chance for loan approval and the possibility of a lower interest rate. This loan can be for various purposes, such as an auto loan for purchasing a car, a student loan for tuition fees or a personal loan for debt consolidation or home improvements.
Another aspect to consider is that co-signing a loan can benefit you, especially if you are the one with a limited credit history. Being the co-signer to a loan when the primary borrower has strong creditworthiness can help you build up your credit score and credit history.
Cons of co-signing a loan
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.
You will also want to consider that your personal relationship with the primary borrower can be tarnished if the loan defaults.
FAQ
How can a co-signer get out of a 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).
Can a co-signer take ownership?
As a co-signer, you share financial responsibility rather than ownership. For example, if you co-sign on a vehicle and the primary borrower stops making payments, you are on the hook for these payments, but you still do not have any claim of ownership because your name is not on the title. Depending on the circumstance, you may want to consider co-borrowing rather than co-signing because that would give you legal ownership alongside the shared financial responsibility.
Does being a co-signer build credit?
Yes, as a co-signer you will be able to build credit and improve your credit score as long as the primary borrower pays on time. However, the opposite is also true. Being a co-signer can also negatively impact your credit score if the primary borrower has a late payment or defaults on the loan.
Does co-signing affect your ability to borrow?
Since co-signing a loan can affect your credit score, it may affect your ability to qualify for a loan. Co-signing will produce a hard inquiry on your credit report and increase your DTI ratio — a factor lenders consider when you apply for a loan.
But co-signing a loan doesn’t have to negatively affect your ability to borrow. 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 ratio will remain in a qualifying range for a loan.
Bottom line
Should you co-sign a loan? Ultimately, the decision is up to you. If you’re financially capable of paying off the debt should the other party fail 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 in your relationship.
