What to Know Before You Co-Sign a Loan
When you co-sign a loan, you make the commitment to settle the obligation in the event that the borrower is unable to make payments for any reason.
This is a kind deed because it can enable a friend or family member to obtain a loan that they otherwise wouldn’t be eligible for. However, it can also be dangerous to guarantee someone else’s loan.
Understand the implications of co-signing a loan and the hazards it poses to your own financial security.
What Does It Mean to Co-Sign?
A co-signer, who adds their name to the application, aids the borrower in getting authorized.
Being a co-applicant is distinct from being a co-signer because the co-applicant is not requesting to utilize any of the loan’s funds. Instead, if the borrower stops making payments or completely defaults, the co-signer promises to pay back the debt.
When a borrower is unable to obtain a loan on their own, co-signers are required. There are numerous causes for this that include:
- Not enough income to cover loan payments
- Poor credit
- History of Bankruptcy
- Lack of borrowing history
Co-signers normally have appropriate credit scores and income to support the loan application. Lenders may opt to accept an application with the co-signer present.
The Risks of Co-Signing
There are hazards involved in assisting a family member (or a close acquaintance) to obtain a loan. Before agreeing to be a co-signer, it’s critical to comprehend what those hazards are.
Damage to Your Credit
Your credit will be negatively impacted along with the principal borrower’s credit if the borrower defaults on the loan as scheduled. Your credit scores will drop as a result of late and missed payments showing up on your credit reports. As a result, getting loans becomes more difficult for you, and there can be other repercussions (like higher insurance rates).
Lenders will expect you to make all required payments as well as any additional interest and fees if you co-sign for a loan.
It makes no difference if the borrower is able to pay but chooses not to or has more money than you do. The lender follows the easiest route to collection wherever possible. When you co-sign, you consent to put yourself in the picture, and it can be simpler to extract money from you.
It is also irrelevant why the borrower isn’t making payments. They could disappear, lose their jobs, die, get sick, or become crippled. The lender will still require the payments to be made, and you must make them fully.
If you don’t make payments, lenders could file a lawsuit. These collection efforts also show up on your credit reports, which hurts your score even more. Additionally, if you refuse to make payments, lenders could be able to deduct money from your bank account and garnish your income. 3
Reduced Ability to Borrow
Other lenders can see that you are accountable for the loan when you co-sign. They, therefore, believe you will be the one making payments.
Your monthly income that is available to make loan payments increases if you co-sign. It’s more difficult for you to be approved for another loan on your own, even though you’re not borrowing and never have to make a single payment on the loans you co-sign for the name.
This can prevent you from accessing money, such as a mortgage or a car loan, when you need to.
Losing Personal Property
You risk losing any personal property you provide as collateral for the loan, such as a car or pricey jewelry. Any property you pledged as collateral may be taken by the lender if the borrower defaults and you are unable to make payments.
No Easy Out
When you co-sign, you start a committed partnership. Because it reduces their likelihood of getting paid back, lenders will be reluctant to release them from the loan.
In some circumstances, it is possible to get oneself released from the debt (or obtain the release of a co-signer), although this can be a difficult process that isn’t always successful. Your likelihood of remaining as a co-signer until the loan’s complete repayment is high.
You only take on responsibility for the debt when you co-sign. Simply because you co-signed, you do not automatically become the owner of anything the borrower purchases.
When Should You Agree to Co-Sign for a Loan?
There may be legal steps you might take to recoup some of your losses if a borrower stops paying payments. But it’s a difficult process, and it doesn’t always work. You might not be able to get back what you lost.
Being a co-signer for an adult kid, a partner, or another close relative may make sense in some circumstances. But how do you tell when a plan is a good one?
You Can Afford the Risk
Only accept a co-signer offer if you have the financial wherewithal to lose the full sum of the loan. If you have a lot of additional cash flow and significant assets on hand to pay off a loan in the event that your borrower defaults, this might be the case.
You will still need to show that you have the income and assets necessary to be approved for any possible personal borrowing. While you might be able to afford the risk right now, keep in mind that you’ll also need to be ready to suffer losses at an unknowable point in the future.
You’re In It Together
Co-signing for someone is something you should only do if you have complete faith in them. If the loan will benefit you both, this is simpler.
It might be more sensible to co-sign if you’re essentially borrowing money from someone else. For instance, your partner might require a little push to get accepted for a car purchase that would be part of your household. In light of this, applying for the loan jointly and becoming a co-owner of the vehicle may be preferable.
You Truly Want to Help
Sometimes all you want to do is help someone else. Significant dangers can come with co-signing, but you might be willing to incur them.
When you co-sign for someone whose financial status you are familiar with and trust, things can occasionally work out just fine. Even so, you still need to be prepared for things to go badly.
Alternatives to Co-Signing
Consider your options before co-signing. There are various options for splitting the cost of a loan that can maintain everyone’s financial security.
Help With a Down Payment
Make a down payment in place of co-signing to help lenders approve your borrower. Lower monthly payments could result from a larger down payment, which would make it simpler for a borrower with a modest income to qualify.
For this option, you need to:
- Have substantial cash on hand
- Be willing to lose that money
- Communicate about how to handle the down payment
Talk about if you’re making a gift and whether you need to create a formal private loan arrangement if you are. A CPA and an attorney should be consulted to detect and prevent any potential problems.
If the borrower can’t otherwise get accepted and you don’t want to co-sign, you can lend the money to them directly. When you are a bank, it is referred to as a private loan.
If you go with the option, be sure that you:
- Can afford to lose the money
- Communicate clearly about expectations
- Get the loan agreement in writing
Private loans do have drawbacks, though. Lending money to friends and relatives can strain interpersonal ties, particularly if the borrower has problems repaying. Without reporting payments to credit bureaus, private loans can also make it difficult for the borrower to establish credit.
Tips for Becoming a Co-Signer
If you determine that co-signing is appropriate for you, take precautions to safeguard both your relationship and yourself. If you have to pay, don’t be shocked; many co-signers wind up paying back all or a portion of a loan.
- Communicate: Stay in close contact with the primary borrower, and encourage communication early and often.
- Get info: Obtain access to all loan documentation and payments. Ask the lender to let you know if there are any missed or late payments or if the loan’s terms alter.
- Maintain current: If the borrower begins to default on the loan, make payments on your own behalf to keep it current and protect your credit. Additionally, you should learn about the borrower’s situation and help them get back on track.
- Reduce the risk: When the only objective is to assist someone in establishing credit, manage your risk by keeping the loan modest and brief. It will take less of your time, effort, and money to repay a small loan that is due in a year or 18 months and that you can afford.
- Obtain release: After the borrower fulfills certain requirements, such as making on-time payments for a predetermined period of time, some loans permit the co-signer to be discharged. To save your personal cash, seize this chance as soon as you can.
It’s a kind deed to assist someone in getting a loan, but you must first be aware of the hazards. Lenders require a co-signer because they are unsure about the primary borrower’s ability to pay to repay in full and on-time.
If a professional lender isn’t comfortable with the borrower, you need to have full trust in them, and the ability to repay the loan yourself if they cannot, before you take on the risk of co-signing someone else’s loan.
Frequently Asked Questions (FAQs)
If my spouse needs a co-signer for a loan, does it have to be me?
No, a lender cannot demand that one spouse co-signs for another. If you are unable or unwilling to co-sign, your spouse may ask another person—such as a parent or sibling—to do so.
Will my co-signer be liable for the debt that was co-signed if I declare bankruptcy?
Your bankruptcy case does not release your co-signer from the debt, even though it may discharge some of your debt, including the loan you obtained with a co-signer. Depending on your circumstances, there can be some changes in how the debt is handled in bankruptcy, therefore it’s advisable to ask your lawyer how it will affect your co-signer.
Does my auto loan co-signer need to be present when I buy a car?
Many of the documentation you’ll sign when you buy a car will require your co-signer to sign it, but they may not have to be present when the deal is sealed. Your business or lender may be able to have your co-signer sign the loan documents electronically, through a service like DocuSign.