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Co-Signing a Loan The Risks and Benefits

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Co-signing a loan The Benefits and Risks
Co-signing the loan may make it easier for the borrower to qualify however it can affect your credit score and general financial health.


Updated on December 16, 2022.

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You might be required to co-sign on a loan by your parent, spouse or friend, especially if your credit score is greater than theirs.
However, what may sound like a noble act helping someone else obtain money to pay for a new home or college tuition -- can have effects you don't anticipate.
What is a co-signer?
A co-signer is someone who is able to add his or her name, credit history and financial information to the principal lender's loan application, and agrees to legally be responsible for the loan amount and any additional fees should the borrower be unable to pay.
A majority of people need or want a co-signer because they can't be eligible for the loan by themselves. If you have a solid financial history, co-signing those with a low credit score or thin credit history can increase the odds of obtaining a loan or getting the lowest interest rate.
Unlike a in which two borrower have equal access to the loan In a co-signed loan, the co-signer has no claim to the loan even though they could be in the position of having to pay.
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Risks of co-signing a loan
Co-signing on someone else's loan puts you in a vulnerable position. Here are the hazards to take into consideration, as well as how to protect your finances and your relationship in the event that you decide to co-sign.
1. You are responsible for the total loan amount
This is the biggest risk co-signing a loan is not just about lending your good credit score to assist someone else. It's a pledge to fulfill their debt obligations if they are unable to do so, including any charges for late payment or collection.
Before you co-sign, assess your personal finances to make sure you can cover the loan repayments in the event that the borrower who is primary will not be able to.
2. Your credit is in the balance
If you sign a co-signing loan and pay it back, both the loan and payment history show up on your credit reports and the lender's.
In the short run there will be a short-term drop in the credit rating, says Bruce McClary, spokesperson for the National Foundation for Credit Counseling. The lender's hard pull on your credit report prior to accepting the loan could affect your score, he adds, and so could the rise in your overall debt load.
Most important, though any missed payment by the borrower could negatively impact your credit score. Because payment history is a factor, a misstep here can wreck your credit score.
3. The credit you have access to could be affected
The long-term risk of co-signing the loan to your loved one is that you might be rejected for credit when you want it. A potential creditor may factor in the co-signed loan to calculate your total debt levels and could decide that it's not risky to offer you additional credit.
McClary recommends checking your credit report regularly after co-signing to monitor your finances.
4. You could be sued by the lender
In some states, if the lender does not receive payments, it could seek to collect funds from the co-signer prior to taking on the principal borrower, according to the Federal Trade Commission.
To reach this point, the borrower would likely have fallen behind on several payments, and the debt may already have begun to impact your credit. The lender is likely to think about legal action if the debt is between 90 and 180 days after it was due.
If something happens that is catastrophic and you're sued for not paying, you're liable as co-signer of all expenses including attorney's fees.
5. Your relationship may be damaged
The borrower might begin paying on time, in full, toward the loan or credit card, with good intentions. But , the financial and personal circumstances alter.
Children who have problems with payments toward a co-signed credit card or car loan may hide the shortfall to their parent until the situation worsens, ruining trust within the family.
Couples going through a divorce often have to deal with the financial implications of a co-signed car or mortgage, according to Urmi Mukherjee, a licensed financial counselor with Apprisen, a non-profit financial counseling company. In such cases it could be difficult to persuade one spouse to pay their share particularly if the spouse has left the house or renounced the car.
6. Removal of yourself as a co-signer isn't easy
If issues arise, removing yourself as the co-signer is not always a straightforward process.
The lenders who allow co-signers to be let out of a loan can require a credit verification of the primary borrower to confirm that they are individually viable to make the repayments independently. Student loans as well as personal loans generally require a specific number of on-time payments before the lender will reassess the primary borrower to see if they can make payments by themselves.
The benefits of co-signing a loan
The upside of co-signing a loan for someone is obvious You can assist the person get access to student loans or credit cards or any other financial product they could not get by themselves or even save them interest with a lower rate.
If someone is brand new to credit or is trying to improve their finances, having a co-signer with a high credit score and an established credit history can be a huge advantage.
There aren't all online personal loan lenders accept co-signers, therefore it is important to verify prior to submitting an application.
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Can co-signing a loan increase credit score?
Being a co-signer can increase your credit score in these ways:
As long as payments are made on time, it adds to your history of payments. However, if you have an excellent score and established credit, the impact could be small compared with the threat to your credit score if the borrower fails to pay.

There's a possibility of a slight advantage if your credit score improves. It's beneficial to keep both installment loans (with low payments) and revolving accounts (like credit cards).

The person with whom you signed is able to build credit these ways:
It may help them qualify for credit that they might not qualify for, as well as improving a weak credit file.

Making on-time payments on the account builds up an excellent credit history.

How to protect your credit if you co-sign on a loan
Before signing a co-signing agreement, you should ask the lender what your rights and responsibilities and how you'll be informed when payment issues arise.
In addition, solicit the primary borrower to grant access to your loan account to allow you to keep track of payments, suggests Byrke Sestok who is a certified financial planner with the New York's Rightirement Wealth Partners.
"It's not an issue of trust, but issues do occur," Sestok says. "If you discover in the first month that somebody is experiencing difficulty paying back the loanand not being able to pay back the loan make a change."
To be prepared for such situations, establish an arrangement between the borrower and co-signer in advance and in writing that spells out expectations for each individual, McClary says. Your private agreement will help in settling mismatched expectations, he says.
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Alternatives to co-signing on a loan
If you're not willing to co-sign on a loan, there are other options for the borrowerto choose from:
Try an individual family loan: If the borrower was hoping to have one of their family members co-sign for them, they could decide to go with a different. A family loan does not require any third-party lenders, which means there's no formal request or approval procedure, however it should include an official, signed contract between both parties that outlines terms. Family loans can help borrowers get cheaper loans and avoid predatory lenders, but they still put the financial security of another person at potential risk should the borrower become incapable of repaying the loan.

Loan collateral: Borrowers may be able offer large-ticket items such as a vehicle or savings account to secure a loan. This is known as and comes with a certain risk. If the loanee is not able to pay the loan the loan, they'll lose the asset they've pledged.

Online lenders that work specifically with applicants who have bad credit. They have less stringent requirements than banks and they will consider other aspects besides credit score. However, interest rates at online lenders could be very high if you have bad credit as they have annual percentage rates that are typically higher than 20 percent.



About the author: Jackie Veling covers personal loans for NerdWallet.







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