There are many situations where you might be tempted to co-sign for a credit card or loan. Here are a few examples:
- An 18-year-old college student can't get a credit card on his own because he only did odd jobs over the summer and recent law changes require that a student be 21 or have sufficient income from a job to pay for a card. Because the child's low income doesn’t make the cut, his parents agree to co-sign for the card, hoping it will teach him how to develop good spending habits and start building a good credit profile.
- A young woman is in a difficult financial situation: Her car broke down, and she needs to get a new or slightly used car to get to her job. She has to finance part of it and needs a co-signer because her credit isn't good enough. Her grandmother agrees to co-sign for the car loan.
- A man wants to put an addition on his house, but he's self-employed and doesn't have a great credit score, so he asks his fiancé to co-sign for the loan since she has a steady job and a good credit score.
Co-signing for a loan to help your child, relative, or friend sounds like a noble act, right? You’re just being the credit booster. However, everyone should be aware of the ramifications of co-signing a loan for anyone, including your child or best friend.
You Are the Borrower
Being a loan co-signer means you are the borrower in the eyes of the credit bureaus, so this loan will appear on the main borrower’s credit report as well as on yours.The timeliness of the borrower’s monthly payments could also impact your credit score if they aren‘t made each month.
Your Future Loans Can Be Affected
If you are planning to get a new loan in the near future, the co-signed loan may negatively affect your chances of getting a new loan or may increase the interest rate you would have to pay because of your higher debt-to-income ratio.
Co-Signers Pay Back
According to the Federal Trade Commission (FTC), studies have shown that of all loans that have had co-signers and gone into default, 75% end up being paid by the co-signer. In some states, if the debt holder misses a payment, the creditor could come after you (the co-signer) for the money. Creditors and banks ask for a co-signer because the potential borrower — your child, relative, or friend — doesn’t have the credit rating and/or income to support the loan. So yes, you would be helping them with your fall-back guarantee, but you would also be responsible for the debt if anything goes wrong.
You Are Fully Responsible
If your child, relative, or friend defaults on the loan payments, not only would you be responsible for paying back the loan, you would also have to pay any late fees and accrued, unpaid interest. The worst case scenario would be that the unpaid debt goes into collections, the creditor sues you, and the court gives the creditor the ability to put a lien on your house or garnish your wages. Of course, your credit score would take a beating in the process.
Consider Carefully
Co-signing for a loan to help your child establish credit may be a good idea if you make the amount small enough that you can pay it if your child defaults, and if you set the monthly payments low enough that your child can afford them. The purpose of your co-signing in this case is to help your son or daughter establish a good credit history, so take the time to explain the consequences of good and bad borrowing behavior. Building a good report will be very important for your child when he or she is looking for a full-time job or wants to move into an apartment.
According to the FTC, a co-signer may be able to limit the potential liability in advance by having a clause in the loan agreement stating you are only responsible for the principal of the loan and that you must be notified if there is a missed loan payment. State laws vary regarding a co-signer’s legal obligation, so make sure you understand your rights and responsibilities in your state before you sign.
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This is a guest post by Hollis Colquhoun. Hollis has over 20 years of experience in the financial industry, is an Accredited Financial Counselor and co-author of Women Empowering Themselves: A Financial Survival Guide. Contact her at Women Empowering Themselves. More articles by Hollis:
FAQs
Before you agree to cosign a loan, ask the main borrower to make a budget and show you how they'll repay the loan. Make sure the monthly loan payments are affordable for both of you. If the borrower loses their job or has a change in finances, can you afford to pay the loan?
What considerations should a cosigner make before co-signing a loan? ›
Before you agree to cosign a loan, ask the main borrower to make a budget and show you how they'll repay the loan. Make sure the monthly loan payments are affordable for both of you. If the borrower loses their job or has a change in finances, can you afford to pay the loan?
What are the 4 Cs of lending? ›
Character, capital, capacity, and collateral – purpose isn't tied entirely to any one of the four Cs of credit worthiness. If your business is lacking in one of the Cs, it doesn't mean it has a weak purpose, and vice versa.
What are the requirements for a co-signer? ›
In addition to having a good-to-excellent credit score, your potential cosigner will need to show that they have enough income to pay back the loan if you default on it. If they don't have sufficient income, they won't offset the lender's risk and may not be able to cosign.
What do lenders look for in a cosigner? ›
Good-to-excellent credit: Your cosigner is your backer, so it makes sense that they should have strong credit. An excellent credit score is best, but try to aim for at least good credit or above (so a score of 670 or higher). Steady income: Your cosigner has to make monthly payments on the loan if you can't.
What makes a strong cosigner? ›
Creditworthiness: A good cosigner will have a credit history with a good credit score, typically above 670, and with no red flags on their credit check. Steady income: Ensure your cosigner has a stable source of income from a steady job or other investments.
How do I protect myself as a cosigner? ›
For example, the lender could include a statement in the contract that “the cosigner will be responsible only for the principal balance on the loan at the time of default.” You could ask the lender to notify you, in writing, if the borrower misses a payment.
Can I still get denied with a cosigner? ›
You can still be denied, but only in rare circ*mstances, most of which will likely not apply to a first-time borrower. A borrower with a poor credit history or negative financial situations, such as bankruptcies or repossessions, will have a harder time getting approved for a loan—even with a good co-signer.
Does co-signing hurt your credit? ›
If you already have a high amount of debt, adding a co-signed loan could impact your own ability to qualify for additional credit. It can affect your credit scores. Because a co-signed loan is recorded on your credit reports, any late or missed payments can have a negative impact on your credit scores.
Who gets the credit on a cosigned loan? ›
Both the primary borrower and the cosigner on a loan will get credit if the primary borrower makes the payments on time. On the other hand, if the primary borrower does not keep up with the monthly payments, both their credit score and the cosigner's credit score will drop.
A cosigner's income is added to yours, so it can give you a big leg up if you have a high debt-to-income ratio (DTI). You have no credit. If you don't have a credit score, the lender will use your cosigner's credit score to qualify you.
Can I cosign with bad credit but good income? ›
The lender will only consider your income when determining whether you meet the requirements. Your co-signer's income will not factor into this part of the application. So, a co-signer with bad credit but good income won't help with approval or better rates.
Can a cosigner increase loan amount? ›
If your income is not high enough to qualify for the loan amount you need, a co-signer's income will be considered by the lender, potentially allowing you to borrow more. If you have a low credit score or a history of bad credit, a co-signer with strong credit can boost your credibility in the eyes of the lender.
Why should a person be very careful before agreeing to cosign a loan? ›
Think carefully before you do. If the borrower doesn't pay the debt, you will have to. Be sure you can afford to pay if you have to and that you want to accept this responsibility. You may have to pay up to the full amount of the debt if the borrower does not pay.
What are the three C's and why they are so important when finding a cosigner? ›
Character, capital (or collateral), and capacity make up the three C's of credit. Credit history, sufficient finances for repayment, and collateral are all factors in establishing credit. A person's character is based on their ability to pay their bills on time, which includes their past payments.
What does a cosigner to a loan must agree to? ›
Co-signers agree to be held legally responsible for a debt should the primary borrower fall behind on what they owe. A co-signed debt also appears on the co-signer's credit reports and may influence their credit scores as if the debt were their own.
What risk does a cosigner take? ›
Co-Signer at Risk for Late Fees, Collection Costs and Legal Action if Loan Is Unpaid: The co-signer is accepting all of the same responsibilities and penalties that a lender can impose, if the loan payments are late or not paid at all.
