Should you cosign a personal loan? Cosigning happens pretty frequently when it comes to personal loans. It’s a way for someone with better credit to help someone who struggles with their finances and credit. This practice is most common among close friends and family members, as it requires a good relationship and trust. But it can also put you in a precarious position if the borrower fails to keep up their end of the bargain.
Like most financial commitments, understanding all the risks and benefits is the best way for you to make the right choice.
Key Points
- A cosigner is someone who is equally responsible for the debt alongside the primary borrower.
- If a payment is missed, the lender can demand payment from the cosigner, the primary borrower, or both.
- Being a cosigner allows you to help someone qualify for a loan that they otherwise couldn’t obtain alone.
- Being a cosigner also means you’re responsible for the loan if the primary borrower defaults, which can negatively impact your credit and limit your borrowing power.
What Does It Mean To Cosign A Personal Loan?
Cosigning a loan means your name is added to the primary borrower’s loan application. That means you are legally obligated to repay the loan if the primary borrower defaults on the loan payments.
A cosigner is needed when the primary loan applicant is unable to get approved on their own merits. In this case, the cosigner’s positive financial and credit profile help strengthen the loan application and increase the odds of approval.
Cosigning Vs. Co-Borrowing
There’s a difference between cosigning and co-borrowing. The main difference is that a co-borrower has a right to the money or property that’s part of the loan, regardless of what type of loan it is. A cosigner, on the other hand, has no right to the property, even though they would be responsible to take over the payments if the primary borrower is unable to.
For instance, joint mortgages typically involve spouses who co-borrow on the loan and each has ownership of the property. Business owners who take out a personal loan together to grow their company each have access to the money. But cosigning simply means both parties are obligated to repay the loan, though the cosigner has no stake in the money or property if the primary borrower defaults.
| Cosigning | Co-Borrowing | |
| Definition | A cosigner agrees to repay the loan if the borrower defaults. | A co-borrower shares equal responsibility for the loan and ownership. |
| Loan Responsibility | Only liable if the primary borrower fails to pay. | Both parties are equally responsible for repayment. |
| Ownership Of Asset | No ownership rights to the asset. | Full or partial ownership of the asset. |
| Effect On Credit | Affects credit score immediately upon signing. | Affects both parties’ credit scores. |
| Income Consideration | Cosigner’s income helps the borrower qualify. | Both incomes are considered for loan qualification and repayment. |
Benefits Of Cosigning A Personal Loan
Some benefits of being a cosigner on a loan may include:
1. It Helps A Friend Or Family Member Obtain Financing
One of the main benefits of cosigning a loan is the rewarding feeling you’ll get for helping someone in need. If you know someone who may otherwise not be able to secure a mortgage to buy a home, your signature on the loan application could mean the difference between approved and denied.
2. May Help Build Credit For Both Signers
As a cosigner, your name be attached to the loan in the same way as the primary signer/borrower. So, each on-time payment made can help build a positive repayment history under your name.
Drawbacks Of Cosigning A Personal Loan
There are more drawbacks to cosigning a loan than benefits, such as the following:
1. You Will Get No “Material” Reward
This is the most obvious reason why cosigning for a loan, a car or even a mortgage could be a bad idea.
There is no “material” benefit to you. You won’t get to drive the car or live in the house, but you’ll be responsible for the payments. You’re simply financially backing the borrower.
2. You Are Responsible For The Loan
If you cosign a loan with someone, you are legally responsible for the loan. If the payments stop being made by the borrower, you will be obligated to pay the debt. This can cause numerous financial problems for you if you are unable to do so. To avoid such a situation, be sure to cosign a loan only when you know you can afford it and you are okay with financially covering the borrower.
| Note: It can affect your credit. Missed payments will not only negatively affect the borrower’s credit score, but yours as well. |
3. You Could Be Rejected For A Loan You Need In The Future
Cosigning a loan now could make it difficult for you to get a loan in the future. This is because your debt-to-income ratio could be too high. When lenders pull your credit report, they will see the loan you are cosigning and will consider it as part of your debts.
Think about your future carefully before you decide to cosign a loan. You might not think you’ll need a loan in the near or even distant future. But you never really know and you don’t want to be rejected if the time comes.
4. Hard To Remove Yourself As A Cosigner
If you change your mind about being a cosigner after you’ve already added your name to the loan, you may find removing your name difficult. You essentially have two options: refinance the loan or pay it off in full.
- Refinance: Your next best bet would be to refinance the loan. In this case, the borrower takes out a new loan without your name on it and pays off the existing loan with the new funds.
- Full repayment: Otherwise, the home will either have to be sold or the loan must be fully repaid to remove your name from the loan.
Learn more: How To Remove Yourself As A Cosigner On A Loan
Other Types Of Loans You Can Cosign
Personal loans are a common loan type that may involve a cosigner to help the applicant get approved. However, other loan programs can also involve a cosigner, such as the following:
- Mortgages
- Car Loans
- Credit Lines
Should You Cosign A Personal Loan?
Before becoming a cosigner on a loan, there are certain important considerations you should make first:
Can You Afford To Cosign A Loan?
If the borrower defaults on the loan, will you be able to comfortably make the additional payments, on top of the bills you already pay for yourself? Even though you may qualify to become a cosigner, you should still make sure you’re fine with taking over the payments if the borrower can’t.
Do You Fully Understand The Contract?
Since you’ll be responsible for taking over the loan if the primary borrower defaults, you’ll want to understand all the contract terms that you’ll be bound to. This includes the payment dates and penalties.
Do You Understand The Risks?
There are several risks that come with being a cosigner. For starters, you’re obligated to repay the loan if the primary borrower fails to keep up with loan payments.
Your credit could also be negatively affected if the borrower misses payments, or if the debt load is more than you can handle. Your ability to secure your own loan may also be impacted due to the added debt you’re taking on.
Finally, your relationship could be harmed. If the borrower fails to make payments on the loan, you’ll be stuck taking over. Naturally, this could put a strain on your relationship, as you may resent the borrower.
Be sure to weigh all the risks of being a cosigner before you agree to this arrangement.
Bottom Line
Wanting to help out a friend or family member is noble, but when you’re asked to help out financially, think carefully about the potential consequences. Depending on the situation, the good can outweigh the bad, but the opposite may also be true. Both parties should have a clear understanding of what cosigning a loan really means so you can lend a hand with confidence.
