Agreeing to cosign a loan for someone is a generous thing to do, and risky. Such a noble deed will show up on your credit report, but the impact won’t always be positive. On the one hand, your credit score might improve if the primary borrower executes timely payments. On the other hand, if the primary borrower reneges on their financial responsibility, your credit score could take a huge hit.
But there’s more to it than that, so let’s examine what you should consider before cosigning a loan, whether for a friend, family member, or business associate.
What Does It Mean to Cosign a Loan for Someone?
Cosigning a loan means that you agree to be responsible for the debt if the borrower does not or cannot repay the loan. You are not the primary borrower, but you could become the primary payer. You can cosign any type of loan — a personal loan, auto loan, mortgage, home improvement loan, or student loan. You can also cosign a lease or make someone an authorized user of your own credit card, which may have a similar effect on your own financial situation.
Why Would a Loan Need a Cosigner?
Typically, a loan requires a cosigner if the primary borrower cannot qualify to borrow the funds on their own. The reason could be that their credit score is too low, they haven’t built up a credit history, or they don’t have a sufficient or steady income. If any of these apply, a lender will consider them to be at high risk of default and choose not to qualify them for a loan.
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How Does Being a Cosigner Affect My Credit Score?
Although you are not the primary borrower when you cosign a loan, your credit score could be impacted. Depending on how good a job the primary borrower does at tracking their money, budgeting, and making payments, cosigning a loan could either boost your score or damage it. Therefore, it’s important to understand how cosigning will affect it.
Risks of Cosigning a Loan
There are serious financial and personal consequences to cosigning on a loan. The biggest risk: Cosigners assume legal responsibility for the debt. If the primary borrower defaults, the cosigner may have to pay the full amount of what’s owed.
If you cosign a loan, it will impact your debt-to-income (DTI) ratio, which is an important factor lenders consider if you apply for a loan. Your ratio may go up if you cosign a loan, making you appear more risky as a borrower, and limiting your ability to obtain credit in the future.
Cosigning may also impact your credit utilization ratio (how much of an allowed line of credit you have used), which is an important factor in computing your credit score.
But there are other potential impacts:
• If a lender conducts a hard inquiry (a type of credit check) on your credit report as part of the loan application process, this may cause a temporary drop in your score, particularly if you apply for other loans or credit cards within a short period.
• If a payment is over 30 days past due, the creditor might report the late payment to the credit bureaus, lowering your credit score.
• If a cosigned vehicle is repossessed, your credit may suffer even if you do not use the vehicle.
• If the account is sent to collections, your credit score will drop.
The relationship you have with the primary borrower also could be damaged if they fail to meet their end of the deal.
The relationship you have with the primary borrower also could be damaged if they fail to meet their end of the deal.
When Cosigning May Improve Your Credit
Your payment history, credit utilization ratio, and credit mix are three factors used to calculate your credit score, and these could all be impacted when you cosign a loan. Cosigning can positively affect your credit score when a primary borrower makes timely payments and pays back the loan according to the terms.
• On-time payments by the primary borrower can have a positive impact on your credit score because they add to your payment history.
• If the loan is paid off according to the terms, this can show that you use credit responsibly.
• The new debt may add to your credit mix. Successfully managing a mix of debt, such as credit cards and installment loans, can boost your credit score. Maybe you don’t have an installment loan. If you cosign on a well-managed installment loan, such as an auto loan, it indicates to lenders that you are a responsible borrower.
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Pros and Cons of Cosigning a Loan
The pros and cons of cosigning a loan depend on the situation.
thumb_upPros of Cosigning a Loan:
• You are helping someone achieve their financial goals by providing access to credit.
• Your credit score may improve if the primary borrower manages the loan responsibly.
• You are diversifying your credit mix, which might boost your credit score.
thumb_downCons of Cosigning a Loan:
• You may max out your debt-to-income ratio, which might limit your own borrowing capacity.
• Your credit score may suffer if the primary borrower makes late payments or misses payments.
• You could lose any assets that you put up as collateral if the primary borrower defaults on the loan.
When Should I Become a Cosigner on a Loan?
The decision to become a cosigner on a loan is a personal one, and it depends on the circumstances of everyone involved. You might want to cosign a loan to help someone achieve their financial goals. Perhaps your son or daughter needs you to cosign on a loan for a car, or someone you want to help needs you to cosign on a personal loan to start a business. It’s up to you to understand the risks involved and to assess the borrower’s ability to honor the payments.
Does being a cosigner show up on your credit report? Yes. So it is not a decision to be taken lightly. Before you agree to cosign on someone else’s loan, it would be wise to check your own credit score to make sure it is healthy. If you decide to cosign, implementing a free credit score monitoring app can help you track the impact on your score.
What Are the Responsibilities of a Cosigner?
The cosigner on a loan is legally bound to pay the debt if the primary borrower defaults. The cosigner is just as responsible for the loan as the primary borrower, even though they may not directly benefit from the loan. This is the case even if the primary borrower files for bankruptcy. If you used assets as collateral to help the primary borrower secure the loan, the lender can sell them to recoup the debt.
It is the cosigner’s responsibility to discuss with the primary borrower their ability to manage their budgeting and spending, pay back the loan in a timely manner, and plan what to do if they find themselves unable to meet their financial obligations.
The Difference Between an Authorized User and a Cosigner
Authorized user is a designation used for credit cards. Cosigners aren’t typically accepted for credit cards. Instead, a person can be designated as an authorized user of another person’s credit card. The credit card owner is the person responsible for the debt, and they give permission for the authorized user to also receive a card and use the account.
Here are the main differences between a cosigner and a credit card-authorized user.
| Cosigner | Authorized User |
|---|---|
| Typically used for loans, such as personal loans, auto loans, mortgages | Typically used for credit cards |
| Only the primary borrower accesses the funds | Both the primary credit card owner and the authorized user access the funds |
What to Consider Before Cosigning a Loan
You will have your own reasons for cosigning a loan. However, here are some things you might want to consider before you take on the risk of another person’s debt.
The Consequences for You
Consider the consequences for your credit score and ability to borrow in the future. If your debt-to-income ratio goes up, your ability to get financing may be reduced.
If you have to assume the payments, creditors can sue you and garnish your wages or bank accounts to collect the outstanding debt. Your credit score updates periodically but the negative impact can persist for up to seven years.
Your Relationship with the Primary Borrower
If the primary borrower benefiting from your generosity manages the payments responsibly, it could strengthen your relationship with that person, However, the opposite could happen if they do not manage the debt well.
How to Monitor the Loan
If you do go ahead and cosign the loan, it’s a good idea to monitor whether the primary borrow is making the payments on time. You might be able to intervene if a problem occurs before the debt is sent to a collection agency. The Federal Trade Commission (FTC) recommends asking the lender or creditor to notify you if the borrower falls behind on their debt. You’ll also want to add the loan to your own personal debt summary so you remember to keep track of it as time passes.
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The Takeaway
Cosigning on a loan can be a way to help another person access credit. However, cosigning a loan can also ruin a relationship and your finances if the primary borrower fails to hold up their end of the bargain.
Before cosigning on a loan, understand what the consequences could be for your credit standing, financial situation, and your relationship. If you decide to go ahead, be clear about the expectations and get an agreement in writing. An agreement won’t absolve you of the responsibility to pay the debt, but it might help in getting the primary borrower to pay you back at a later date when they may be in a better financial situation.
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FAQ
Will my credit score go up if I have a cosigner?
Your credit score could go up if you have a cosigner, because if you are approved for a loan with a cosigner and you make timely payments, it will add positively to your credit history, which will also favorably impact your credit score. Having that cosigned loan could also improve your credit mix, another plus where your credit score is concerned.
Is cosigning bad for your credit?
It can be. If the primary borrower does not make payments on time or if they default on the loan, it will negatively affect your credit. It could also be bad for your credit if your credit utilization ratio increases. However, cosigning for a loan could also be good for your credit if payments are made on time and/or your credit mix improves.
Who gets the credit on a cosigned loan?
Both the primary borrower and cosigner are impacted by the cosigned loan. A cosigned loan typically appears on both credit reports, and the cosigner is responsible for paying back the loan if the primary borrower fails to do so.
Photo Credit: iStock/flzkes
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