Cosigning a loan is a good way to help out someone in your life who is struggling to get one — whether a student or personal loan — on their own terms. This may be because they do not meet the lender’s credit score requirements or they do not yet have a sufficient credit history or income (as is often the case with students).
While you might feel tempted to move quickly to help out a loved one, cosigning has some serious and long-lasting implications. Here is what to consider before signing your name on any dotted lines.
What exactly does it mean to cosign a loan?
When you cosign a loan, you effectively “sign jointly with a borrower for a loan,” said Investopedia. This entails adding your “name, credit profile and financial information to the primary borrower’s loan application, agreeing to be legally responsible for the loan amount, and any additional fees, should the borrower be unable to pay,” said NerdWallet. However, unlike a co-borrower, cosigners do not have any rights to the loan funds or whatever those funds are used for.
Serving as a cosigner can “help a borrower obtain more favorable loan terms than they might otherwise have been approved for” and potentially “qualify for a higher amount of principal,” said Investopedia. Ultimately, how much of a boost you provide as a cosigner depends on your own creditworthiness, which will be evaluated alongside the borrower’s in the application process.
What are the potential risks of being a cosigner?
While acting as a cosigner can be a nice thing to do for a family member or close friend, it comes with “significant risks,” said Credit Karma. That’s because, as a co-signer “you’re legally responsible for the loan if the primary borrower can’t make the repayments.”
The borrower’s failure to make payments can not only put you on the line to do so, but it also can “affect your credit scores, increase your debt-to-income ratio and potentially lead to legal action if the loan isn’t repaid,” said Credit Karma.
If your credit takes a plummet due to the borrower’s lack of payment, or because the addition of the loan drives up your debt-to-income ratio, “your access to credit may be affected,” meaning “you may be rejected for credit when you want it,” said NerdWallet.
What should you consider before agreeing to cosign?
The possible risks of cosigning are crucial to weigh, but that is not all you should take into consideration. You will also want to evaluate your personal financial situation and whether this additional debt is really an obligation you can take on. Ask yourself if you could weather potential negative impacts down the road.
Also important: “Think about your relationship with the primary borrower and consider how well you can trust them,” said Bankrate. Do not just “consider your relationship with the primary borrower as it stands, also think ahead to how future collections calls could lead to strife” — and if you do not foresee things going well, “it’s best not to agree to cosign in the first place.”
Consider the long-lasting implications before helping out a loved one
