If you have good credit and finances, you may have friends and family asking you to be their cosigner. Co-signing a loan can help your friend or a family member qualify for a loan more easily. Moreover, they may be able to secure a lower interest rate and better terms with you as a co-signer.
Unfortunately, not everyone understands the responsibilities that come with co-signing a loan. Find out what co-signing a loan really means and all the important information that you need to know.
A co-signer is someone with good credit and a healthy income who promises to continue making loan payments in case the borrower defaults on the loan. This makes the loan application more attractive to the lender because it reduces their risk.
Co-signers can also help primary borrowers get a lower interest rate or better loan terms.
But being a co-signer comes with significant risk. Those who act as co-signers may help another person qualify for a loan, but it means they’ll be responsible for paying off the debt if the primary borrower can’t afford their payments.
Before you decide to co-sign a loan for a family member or friend, consider the following risks and dangers with co-signing a loan.
When you co-sign any loan such as a car loan or mortgage, there is no benefit to you at all. You’ll assume all responsibility for the loan in the event the primary defaults and you won’t get to drive the car or live in the house you’re cosigning for.
If you co-sign a loan for someone, you are wholly responsible for the loan. That means, if the primary borrower is unable to make payments, misses a payment or stops making payments, you’ll be responsible for the payments they did not make.
If you do not continue to make the loan payments in the primary borrower’s stead, it could have severe negative repercussions on your credit score and finances.
Even though you’re just co-signing on a loan and aren’t the primary borrower, the debt will still be added to your credit report. As such, any late or missed payments will also be reported, which can negatively impact your credit score.
If the primary borrower completely stops making payments and the loan is sent to collections, this will also be reported to the credit bureaus. If the collection agency is unable to get hold of the primary borrower or cannot collect the missed payments, they’ll come after you for the money.
Even if your friend or family member swears up and down every month that they are making the payments, you will still need to check for yourself. Simply putting it to the back of your mind and not checking up on them every month will not be an option. You will have to treat it like all of your other monthly bills and stay organized and on top of it.
Because you are now financially and legally responsible for someone else’s loan you’ll probably want to start checking up on your friend to see if they are in fact making the payments on time. This could cause some tension in your relationship. If the other signer thinks that you don’t believe they can make their payments on time then there could be some issues.
Personal relationships and money don’t mix very well; keep that in mind if you’re thinking about co-signing a loan with a friend or family member
There are several tax issues that could arise in various situations. For example, if you’re co-signing on a mortgage and the primary borrower sells the home down the line, you could be required to pay a share of capital gains taxes if the property is sold at a profit.
Lenders look at several factors when deciding whether or not to approve an applicant for a loan. One of these factors is your debt-to-income (DTI) ratio, which refers to the amount of debt you carry relative to your income.
While you’re not required to pay the co-signed loan, you may have to in the future if the primary borrower defaults. As such, lenders will consider your cosigned loan when calculating your DTI. This can lower your borrowing power as your income may not be sufficient enough to add a new loan due to the loan you co-signed.
Think about your future carefully before you decided to co-sign 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.
You may have to sue the primary signer in order to get them to help you pay off the unpaid loan. Obviously, legal action is a last resort but it is a possibility, one that you might not want to have to deal with. There are endless issues with trying to sue someone for a co-signed unpaid loan, and in the end, you might have to pay for the whole loan anyway.
If you change your mind about being a co-signer and decide to back out of the loan contract, you may find that removing yourself from the agreement is not easy. You can’t just have your name taken off the loan contract. Instead, you may have to undergo a more complicated process to back out of your commitment.
For instance, refinancing the loan may be a way to remove yourself from the loan, but that would require the primary borrower to be able to qualify for a new loan on their own. The reason you initially added yourself to the loan was because the primary borrower was ineligible based on their credit or financial profile. If things haven’t changed, refinancing might not be possible, which means you’ll still be on the hook.
The decision to become a co-signer is an important one that requires careful consideration. Follow these steps before co-signing a loan contract:
If you change your mind at some point after you’ve signed the loan agreement as a co-signer, you’ll need to follow the terms of the loan contract regarding your right to get out of the deal.
Wanting to help out a friend or family member is never a bad idea but when they ask you to put your finances on the line, you should think carefully about the consequences. If you co-sign a loan you’ll be responsible for any defaulted payments by the primary lender. Moreover, this can not only hurt your credit but your finances as well. Lastly, co-signing can impact your debt-to-income ratio which can make it difficult for you to qualify for a loan, if you ever need one in the future.
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Lisa has been working as a personal finance writer for more than a decade, creating unique content that helps to educate Canadian consumers in the realms of real estate, mortgages, investing and financial health. For years, she held her real estate license in Toronto, Ontario before giving it up to pursue writing within this realm and related niches. Lisa is very serious about smart money management and helping others do the same.
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