Being the cosigner on a loan is a commitment that shouldn’t be taken lightly. It may be tempting to help out a loved one by agreeing to be their financial backup, but you could be putting your own credit reputation in jeopardy if the primary borrower on the loan doesn’t follow through on his or her obligation.
Here’s what you need to know before you sign on that dotted line.
Key Points
• Cosigning a loan involves significant financial obligations, including covering missed payments and potential legal actions if the primary borrower defaults.
• Cosigning can impact your credit score and debt-to-income ratio, affecting future borrowing opportunities.
• Cosigners have legal responsibilities similar to the primary borrower and may face collection actions if payments are missed.
• Alternatives to cosigning include taking out a loan yourself or lending money directly to the borrower.
• It’s crucial to understand the risks and maintain communication with the borrower to protect your financial interests.
What Is a Cosigner?
If someone isn’t a good candidate for a loan, a lender may allow them to add a better-qualified cosigner to their application. This can help a high-risk borrower improve their chances for getting a loan or better loan terms. Plus, cosigning can help the cosigner and primary borrower build credit.
Essentially, a cosigner agrees to take over financial obligations should the main borrower miss payments or default on the loan. They won’t get the borrowed funds, and if the loan is used to purchase an asset, like a car or home, they won’t be listed as a co-owner. But they are just as responsible as the main borrower for making sure the debt is paid.
This is a different arrangement from using a co-borrower, where that person takes on the loan with the main borrower and has part ownership in whatever the loan buys.
Primary Responsibilities of a Cosigner
What is the responsibility of a cosigner on a loan? Being a cosigner means you’re willing to accept two important roles. Let’s take a closer look at both.
Financial Obligation
It’s important to fully understand your financial obligation before accepting the role of cosigner.
To be clear, you aren’t just serving as a character witness, telling the lender that you trust your friend or loved one will make good on the loan. You’re signing an agreement that says you’ll pay if he or she doesn’t.
This means if the primary borrower is delinquent, you should be ready for the lender to come to you for the missing payment or payments. And if the borrower defaults, the lender may ask you for the balance. You also may have to pay any late fees or collection costs.
If you can’t fulfill your role as cosigner, the lender can use the same methods to collect as it would with a primary borrower, which includes taking you to court.
Credit Risk
Cosigning a loan can have the same effect on your credit as if you applied for and got the loan for yourself.
A lender will likely perform a hard credit inquiry, which can lower your credit score temporarily by just a few points. And the account can show up on your credit reports, just as it does for the main borrower. That means it can potentially impact your credit scores, your future borrowing, and your own financial goals.
Types of Loans That May Require a Cosigner
Although most major credit card issuers don’t accept cosigners, lenders will allow a cosigner on many different types of debt if a borrower’s application needs a boost. Examples include:
• Student loans
• Mortgages
• Leases
• Auto loans
No matter the type of loan, it’s a good idea to consider the potential risks before agreeing to cosign.
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Legal Implications of Cosigning
When you’re the cosigner on a loan, you’re signing a contract that outlines your legal obligations and the consequences if you don’t follow through on your commitment. This includes making monthly payments if for some reason the primary borrower won’t or can’t.
In this way, the arrangement is different for a guarantor vs. cosigner: A guarantor is only responsible if the borrower defaults, while a cosigner is responsible if the borrower misses one payment.
It may feel awkward, but as a cosigner, it’s your responsibility to monitor the account and ensure payments are made on time — even if the borrower or the lender doesn’t notify you that there’s a problem.
It’s also important to note that, depending on state law, the lender may decide to sue a cosigner for late payments or even the full amount due before trying to collect from the main borrower. A lender also may take action to collect from a cosigner before moving to take the car, home, or other asset that’s being used as collateral to secure a loan.
Impact on the Cosigner’s Credit
When someone offers to cosign a loan, it’s usually with the intention of helping out a person they care for until that person can establish their own good credit reputation. But if all goes well, the cosigner could benefit, too.
If the main borrower stays on track and makes timely payments, and those favorable account updates appear on the cosigner’s credit reports every month, it could result in a boost to the cosigner’s credit score.
The big drawback, of course, is that any negative information (such as late or missed payments or if the debt goes to collections) can also affect the cosigner’s credit. And even if the main borrower does everything right, becoming a cosigner can affect your debt-to-income (DTI) ratio and your credit utilization. This, in turn, could impact the interest rate or other terms you’re offered if you apply for your own loan or credit card down the road.
Additional Risks of Being a Cosigner
Along with the financial risk and the potential impact on your credit, it’s important to consider the effect cosigning a loan might have on your personal connection with the main borrower. You both may go into the arrangement with the best intentions, but if things go sideways, it could put stress on even the strongest relationship. A serious conversation about your expectations — and theirs — may help.
Remember: Even though you aren’t directly giving that person the funds they need, you are lending him or her your good credit reputation for the length of the loan. And you’ll both have to deal with the fallout if the arrangement doesn’t work out.
Do Cosigners Have Any Rights?
Before you cosign most types of loans, you are entitled to receive a separate disclosure that outlines your rights and obligations. This document, labeled “Notice to Cosigner,” is required under the Federal Trade Commission (FTC) Credit Practices Rule, and it includes warnings about your financial commitment, your credit risk, and potential debt collection methods.
After you cosign, you have the right to ask for updates about the loan’s payment history and outstanding balance at any time.
How to Protect Yourself as a Cosigner
Here are a few steps that could help you safeguard yourself and your relationship with the main borrower before agreeing to cosign on a loan:
• Talk to the main borrower about their current finances. Are you sure they can cover the monthly loan payments along with their other obligations? Are you clear about what the money will be used for, the total amount being borrowed, and why a cosigner is needed? A personal loan calculator can help you determine what the monthly payments might be, depending on the interest rate and loan term.
• Ask the main borrower for progress updates. Since it will be your responsibility as a cosigner to ensure payments stay on track, discuss how you can monitor the main borrower’s progress in a way that works for both of you.
• Ask the lender to keep you in the loop. If you want to receive copies of loan statements, let the lender know. And be sure that you’ll be notified ASAP if there are late or missed payments.
• Carefully read the “Notice to Cosigner.” This brief document can help you understand your rights and obligations.
• Get copies of all relevant loan documents. Keep any important paperwork handy so you can refer to it when necessary.
• Keep an eye on your credit. Your bank, credit card company, or a money tracker app may allow you to check your credit score for free. And you can go to AnnualCreditReport.com to get free credit reports from each of the three major credit bureaus.
Alternatives to Cosigning
If you aren’t comfortable with the risks involved with cosigning, here are some alternatives you may want to consider:
• Take out the loan yourself and ask your loved one to repay you. Although there’s still a risk that you won’t get all your money back, as long as you stay on track with your loan payments, your credit will stay intact.
• Fund the loan from your own savings. If you have the means to lend the money directly to your loved one, a family loan can remove credit risk from the borrowing equation. Unfortunately, bypassing the lender also eliminates both the borrower and cosigner’s opportunity to build credit through timely payments. To keep things more formal, and help avoid default risk, you can write up a payment plan and charge interest as part of your agreement.
• Just say no. If you aren’t comfortable with a cosigning arrangement, it may make sense to follow your gut and turn down the request.
Removing Yourself as Cosigner
Getting your name off a loan you’ve cosigned can be extremely difficult, which is yet another good reason to give the arrangement a lot of thought before you agree to it. Here are some options to explore:
• Cosigner release: Student loan borrowers may have more luck applying for a cosigner release than other types of borrowers. But even if it’s an option (which you should be sure of before cosigning), the primary borrower still will have to agree to it and meet certain criteria before applying for the release. And the lender will have to approve it, too.
• Refinancing the loan: With this option, the old loan is paid off and the primary borrower gets a whole new loan that doesn’t require the current cosigner.
• Paying off the loan: If it’s a secured loan, such as a home or car loan, the borrower could agree to sell the asset and pay off the loan, removing the cosigner from any financial responsibility. If it’s an unsecured loan, and the main borrower or the cosigner has the means to pay it off early, they might decide to do so in order to end the arrangement and move on.
Recommended: Average Personal Loan Interest Rates and What Affects Them
The Takeaway
Agreeing to cosign a loan for a friend or loved one is a generous act. But even in a best-case scenario, it can be a lopsided arrangement, with the cosigner taking on most of the risk and the primary borrower seeing most of the benefits.
If you decide to go forward, it’s important to find a loan that fits the borrower’s budget to improve the chances of their success. As a cosigner, it also can be helpful to monitor payment progress as well as any changes to your own credit score.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
FAQ
What happens if the primary borrower defaults on the loan?
As a cosigner, you are responsible for making sure the primary borrower’s loan is repaid on time. If the borrower is delinquent or defaults, you can expect the lender to come to you for payment.
Can a cosigner be removed from a loan?
It’s possible but difficult for a cosigner to be removed from a loan. It can be helpful to ask the lender about your options before you agree to cosign.
Does cosigning affect my ability to get my own loans?
Yes. Even in a best-case scenario, where the borrower consistently makes on-time payments, cosigning a loan can affect your credit score, debt-to-income ratio, credit utilization, and other factors that lenders look at when you apply for a loan or credit card.
Photo credit: iStock/DMP
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