Understand the Nitty-gritty of Becoming a Co-Signer
A co-signer helps a borrower get approved by adding their name to the application. This is not the same as been a a co-applicant; [a co-signer is not applying to use any of the money in the loan], however, the co-signer by signing, enters into a legally binding agreement that guarantees that they will repay the loan if the borrower stops making payments or defaults entirely.
A co-signer is someone who adds their name to the primary borrower’s loan application, agreeing to be legally responsible for the loan, lease or similar contract and any additional fees, should the original borrower be unable to pay. Most people need a co-signer because they do not qualify for the loan by themselves. So it becomes necessary for them to have someone with a strong financial profile, co-signing for someone with a lower credit score or thin credit profile can improve their odds of qualifying or securing a lower interest rate.
Cosigning a loan does not mean your finances or relationship with the borrower will be negatively affected, but it’s not a decision you should only take after due and critical considerations.
Make sure you both understand what is required of you as the cosigner, and together weigh the pros and cons of this action on your relationship. Take special care to discuss what will happen should the borrower be unable to keep up with their payments as agreed and ensure they understand how you may be affected as well.
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The benefits of cosigning a loan.
Obviously, the most benefits of co-signage accrues to the original borrower. It can also, however, be a great way, for example, to help your child build credit. Cosigning for your another individual allows them to start building the credit history they need while reassuring the lender that they will get repaid.
Possible disadvantages of cosigning a loan.
Cosigning comes with its own risks, this is especially since it means you are practically bearing all of the legal responsibilities and obligations for the account. Basically, this means that the loan will reflect on your credit report. Hence, if the main borrower defaults in any payment on the loan, it will appear in your credit report and the lender may require you to pay for it.
It could limit your borrowing power and Damage to Your Credit.
Potential creditors decide whether or not to lend you money by examining your existing debt-to-income ratio. Depending on how much debt you already have, the addition of the cosigned loan on your credit reports may make it look like you have more debt than you can handle. As a result, lenders may shy away from you as a borrower.
If the borrower does not repay the loan as agreed, your credit suffers along with the primary borrower’s credit. Late and missed payments appear on your credit reports, which will cause your credit scores to fall.
As a result, it gets harder for you to get loans, and there may be other consequences (like higher insurance rates).
It could lower your credit scores.
Because that debt shows up on your credit reports as if it were your own, your credit scores will be affected by any late or missed payments. If the borrower stops paying altogether and the loan goes into collection, that could also go on your credit reports, and the bill collectors could come after you to get their money. Lenders or collectors could even sue you, garnish your wages or put a lien on your property in an effort to collect the balance of the debt.
It could damage your relationship with the borrower.
You should also consider how cosigning a loan might impact your relationship with the borrower. You’ll be tied to this person, and any possible financial upheavals, for the term of the loan, whether that’s six months or 10 years. You’ll be responsible for repayment if the borrower has financial difficulties or if something else goes wrong, and your relationship could suffer.
The borrower may start out making full, on-time payments toward the loan or credit card with good intentions. But financial and personal situations change, and thus could lead to a breakdown of your relationship as well. As with many aspects of personal finance, there’s nothing wrong with helping out a friend or family member in need. Just make sure that you’re ready for any impact on your own financial situation before you lend a hand to a loved one.
Litigation and legal Issues
If the lender does not receive payments, it can try collecting money from the co-signer before going after the primary borrower, according to the Credit Bureau.
To get to that stage, the borrower would likely have missed several payments, and the debt would already have started to affect your credit. Lenders are likely to consider legal action when the debt is between 90 and 180 days past due.
If the worst happens and you are sued for nonpayment, you’re responsible as the co-signer for all costs, including attorney’s fees.
Losing Personal Property
If you pledge any personal property as collateral for the loan, such as a car or valuable jewelry, you can lose that property.
You are responsible for the entire loan amount with no ownership.
This is the biggest risk: Co-signing a loan is not just about lending your good credit reputation to help someone else. It’s a promise to pay their debt obligations if they are unable to do so, including any late fees or collection costs. Before you co-sign, assess your own finances to ensure you can cover the loan payments in case the primary borrower cannot.
When you co-sign, you become responsible for the debt only. You don’t own whatever the borrower buys, and you have no right to the property just because you co-sign.
Removing yourself as a co-signer is difficult.
If issues arise, removing yourself as the co-signer is not always a straightforward process. Refinancing the loan is one way to have yourself removed, provided that the primary borrower can now qualify for a new loan on their own. Student loans or credit cards typically require a certain number of on-time payments before the lender will reassess the primary borrower to see if they can make payments on their own.
Safety Tips for Becoming a Co-Signer
If you decide that co-signing is right for you, manage the risks to protect yourself and your relationship.
- Communicate: Stay in close contact with the primary borrower, and encourage communication early and often.
- Get all necessary information: Get access to all the loan paperwork and payments. Request that the lender informs you of any late or missed payments, or if the terms of the loan change.
- Keep up with current occurrences: If the borrower starts missing payments, make payments yourself to keep the loan current to avoid damage to your credit. You’ll also want to find out what’s going on with the borrower and get them back on track.
- Manage the risk: When the goal is simply to help somebody build credit, manage your risk by keeping the loan small and short-term. A small loan you can easily pay off that’s due within a year or eighteen months will require less of your time, energy, and financial investment.
- Get released: Some loans allow a co-signer to be released after the borrower meets certain conditions, such as making on-time payments for a certain amount of time. Take advantage of this opportunity as soon as possible to protect your own finances.
What are the Alternatives to Co-Signing?
Before you co-sign, evaluate the alternatives. There are other choices for sharing some of the burden of a loan that can keep everybody’s finances safe and secure.
- Assist With a Down Payment: Instead of co-signing so that lenders approve your borrower, help out with a down payment instead. A bigger down payment could result in lower required monthly payments—making it easier for the borrower to qualify with limited income.
- 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
- Discuss whether or not you’re making a gift, and if you need to set up a formal private loan agreement. Check with a CPA and attorney to identify and avoid any potential issues.
If you are helping with a down payment, some lenders may require you to submit a “gift letter,” which states that the amount you are contributing doesn’t need to be repaid.
- Lend Instead: You can lend the money yourself if the borrower can’t otherwise get approved and you don’t want to co-sign. This is called a private loan, where you are the bank.
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
- There are downsides to private loans, however. Loaning money between family and friends can make personal relationships awkward, especially if the borrower has trouble repaying. Private loans can also make it difficult for the borrower to build credit unless you report payments to credit bureaus.
- Get a personal loan with bad credit: There are online lenders that work specifically with applicants who have bad credit. These lenders have looser requirements than banks and will evaluate other factors besides credit score. However, interest rates at online lenders can be high if you have bad credit, with annual percentage rates typically above 20%.
- Offer collateral: A borrower might be able to offer big-ticket items like their home, car or even an investment or savings accounts as collateral on a loan. This is known as a secured loan and comes with its own risk. If the borrower is unable to make payments on the loan, they will lose whatever asset they’re pledging.
- Try a family loan: If the borrower was hoping to have a family member co-sign for them, they could opt for a family loan instead. A family loan doesn’t involve a third-party lender, so there’s no formal application or approval process, but it should include a notarized, written agreement between the two parties summarizing terms. Family loans can help borrowers get cheaper loans and avoid predatory lenders, but they still put another person’s finances at risk should the borrower be unable to repay the loan.
Summary
Helping somebody get a loan is a generous gesture, but it’s critical to understand the risks before doing so. There’s a reason a lender wants a co-signer: they are not confident that the primary borrower can repay in full and on-time.
Therefor, a decision to co-sign must be weighed against the most stringent of reasons before it is embarked on.