If you have a family member who’s having trouble securing a loan or credit product on their own, they may ask you to be a co-signer. While doing so is a noble act, it’s also a huge financial responsibility. If the borrower fails to make payments, you may be on the hook to pick up the slack.
But in addition to the extra money you’ll need to pay as a cosigner, what effect could this have on your credit health? Does cosigning affect your credit?
Key Points
- Cosigning a loan can have a negative effect on your credit score if the primary borrower defaults on the loan.
- Being a cosigner can also make it more difficult to get approved for loans for yourself.
- Before cosigning, be sure you understand the impact it may have on your credit and ability to qualify for future loans.
What Does Cosigning A Loan Mean?
A cosigner on a loan agrees to repay the loan if the primary lender ceases to make payments or defaults on the loan. By cosigning a loan, you aren’t responsible for the payments if the person who took out the loan keeps up with their payments. It’s only once they stop making payments that you may have to take over as a co-signer.
Reasons Someone May Need A Co-Signer When Applying For A Loan
People make use of a cosigner for various reasons:
- They have poor credit
- They have little or no credit history
- They earn a low income
- They’re considered risky in the eyes of the lender, such as being a student
Basically, in any situation where the primary lender is a risky candidate for a loan, a more reliable cosigner can be used to help the primary lender obtain a loan. It’s more common practice for parents, spouses, relatives, siblings, and even close friends to cosign loans.
Will Cosigning A Loan Negatively Affect Your Credit Score?
Cosigning a loan may affect your credit scores in a few ways.
Cosigning A Loan Will Show Up On Your Credit Report
If you cosign a loan, it will appear on your credit report as well as the primary lender’s credit report. This is because you’ve made a commitment to repay the loan should something go wrong. Your credit report will reflect an increase in the number of accounts with balances.
| Note: It’s important to note that if the cosigned agreement is a lease, as opposed to a loan, it will not appear on your credit report. A lease is not technically debt because no loaned money has exchanged hands. It’s merely an agreement to pay a specified amount for a given period. |
Negative Remarks About The Loan Can Pull Your Score Down
Since the cosigned loan will appear on your credit report, negative remarks about the loan will be noted, which can hurt your credit score. Such remarks can include the following:
Late Or Missed Payments
A payment that is more than 30 days overdue may be reported to the credit bureaus by the lender. Late payments that are recorded on your credit report can hurt your credit score.
Asset Repossession
If the loan in question is secured by an asset of value, the asset may be at risk of repossession if you and the primary borrower default on the loan. This may be noted on your credit report and can pull your credit score down.
Account Sent To Collections
When loan payments are missed, the lender may get a collection agency involved to go after the borrower in default. Since you’ve cosigned the loan, a collection account may be opened on your own credit report. In turn, this may hurt your credit score.
What Can You Do If The Borrower Defaults On The Cosigned Loan?
If the primary borrower defaults on the loan, it can not only negatively affect your relationship with them, but your credit score may also suffer, as mentioned.
While several factors play a role in determining your credit score, payment history generally matters the most. If the borrower misses their loan payments, that will be noted on your credit report and, you’ll be just as affected by the missed payments as the primary borrower.
If this happens, you’ve got a couple of choices:
Pay Off The Loan Yourself
If the borrower fails to keep up with payments, you’d be obligated to take over the loan payments as the cosigner. You essentially made this promise when you signed on as a co-signer. Unfortunately, even though you’re the one repaying the loan, you won’t have any stake in the asset, whether it’s a house, car, or money.
Allow The Loan To Default
If you’re financially incapable (or unwilling) to pay off the loan on your own, the loan will default. When this happens, your credit report will reflect this default, which can negatively affect your credit score.
Loan defaults can stay on your credit report for up to 6 to 7 years, which can make it difficult to get approved for a loan in the future.
Neither one of the above scenarios is a positive one, which is why it’s crucial that you think carefully about taking on the responsibility of being a co-signer.
Can Cosigning A Loan Help Improve My Credit?
If the loan is kept in good standing, both the primary borrower and cosigner may be able to improve their credit over time. That is, as long as all other aspects of their finances are handled properly. That’s because timely payments are reported to the credit bureaus and will show up on your credit report.
Despite the added responsibility and risk of being a cosigner, you may be able to use this role as an opportunity to strengthen your credit score.
Will Cosigning A Loan Affect Your Ability To Borrow?
If you plan on applying for a new loan soon, the existing debt from the cosigned loan could affect your ability to get approved for a loan.
Lenders often consider what you potentially owe (i.e. the total amount of the loan you cosign) because it could impact your ability to repay them in the future. The added debt from the cosigned loan might make you a riskier borrower in the eyes of the lender, which may also lead to a higher interest rate.
Why Do Lenders See Cosigners As Risky Borrowers?
With added debt and a higher debt-to-income ratio, your available income may be impacted, which can increase the odds that you may miss payments in the future on a new loan you apply for. Further, the risk of having to assume payments on a loan you cosigned looms, which could make some lenders a bit apprehensive about. In turn, they may be less willing to extend a loan to you.
Can I Remove Myself As A Cosigner?
To remove yourself from the loan you cosign, you’ll need to review the contract to see if there is a clause that allows you to take your name off the loan. If not, removing yourself as a cosigner can be challenging.
One way to remove yourself as a cosigner would be to refinance the loan. In this case, the borrower would have to qualify for a new loan on their own. Otherwise, the loan would have to be paid off in full so you can be relieved of your co-signing duties.
Final Thoughts
Cosigning a loan can either affect you positively or negatively, depending on how the loan is managed. While helping out friends and family is great, be sure to consider all the risks before agreeing to become a cosigner. If you do cosign a loan, you’ll be adding more debt and may have to take over payments if the primary borrower defaults. Communication with the primary borrower is key to ensuring that payments aren’t missed.
