Should you cosign a loan? Most people have mixed feelings about whether or not co-signing a loan is a good idea. The root of the issue is that most don’t really understand what co-signing a loan entails.
Co-signing 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.
Like most financial commitments understanding all the risks and benefits is the best way for you to make the right choice.
What Does It Mean To Cosign A Loan?
Co-signing 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.
Other Perks Of Having A Cosigner
- To Get Better Interest Rates – Unfortunately, people with bad credit may have to pay higher interest rates because they are seen as high risk by lenders. But if they are able to get a cosigner who has a good credit history. They could benefit from that person’s credit strength and therefore be offered a more affordable interest rate.
- To Build Credit – To build your credit scores, you need to get credit, which can be difficult for people with a bad financial history or no history at all. This is where a cosigner can be beneficial. Someone who has a good credit history can cosign a loan to help a person with bad credit get a loan and therefore help them build their credit.
- To Avoid Predatory Lending Practices – By getting a cosigner you can avoid predatory lenders who prey on those looking for a loan but have bad credit.
Co-Signing vs. Co-Borrowing
There’s a difference between co-signing 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 co-signing 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.
Benefits Of Co-Signing A Loan
There are a lot more benefits for the borrower than there are for the cosigner. Some benefits may include:
1. It Helps A Friend Or Family Member Obtain Financing
One of the main benefits of co-signing 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. Take out a car loan to purchase a vehicle or any other type of loan that will help financially. Your signature on the loan application could mean the difference between approved and denied.
2. Helps Build Credit For Both Signers
Since you’ll be attached to the loan in the same way as the primary signer/borrower, your credit can also benefit if the loan payments are made on time.
Drawbacks Of Co-Signing A 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 co-signing 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. It’s also important to keep track of these payments. 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.
3. You Could Be Rejected For A Loan You Need In The Future
Co-signing 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 co-signing and will consider it as part of your debts.
Think about your future carefully before you decided 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. It Can Affect Your Credit
Since you have taken on the responsibility of being a cosigner you need to protect yourself and your credit scores. Put aside some money just in case the other signer defaults and be prepared for the worst. Missed payments will not only affect the borrower but your credit as well.
5. 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. To do so, the borrower may have to refinance the loan to have you removed.
But this requires the borrower to be able to qualify for a new loan on their own merit. If the borrower is unable to qualify, refinancing may not be an option, which means you may be stuck being a cosigner until the loan is fully paid off.
Otherwise, you may need to wait until the loan is paid off or for the home to be sold to cut financial ties. But in these cases, it’s the borrower who has the power.
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Should You Cosign a 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, penalties, and so forth.
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.
Can And Should You Cosign A Loan?
Wanting to help out a friend or family member is never a bad idea. But when you’re asked to help them out financially you should think carefully about the consequences. Depending on the situation the good can outweigh the bad but the bad can also outweigh the good. The best idea for both parties is to have the best understanding of what co-signing a loan really means, that way if you have the opportunity to help out a friend you’ll be able to say yes with confidence.
