When a family member, spouse, or friend doesn’t have a high enough credit score to take out a loan, cosigning for them is one of the only ways they’ll be able to borrow that money. But cosigning comes with a price.
If you are (or were at one time) a new college graduate, you’ve probably run into situations where you want to sign a lease for an apartment, buy a new car, or take out a credit card but found you’ve got little to no credit to do so. That’s very common for twenty-somethings. And the first thing a bank, lender, or landlord will tell you is to find a cosigner.
In short, a cosigner is someone who has decent credit, offering to take over a loan for you if you fail to make payments. They’re the bank’s backup in case they don’t get paid by the original borrower.
But before you beg your parents to cosign a loan, there are some things you (and your cosigner) should be aware of. Cosigning shouldn’t be something that’s done lightly. It can have a lot of negative consequences.
What’s Ahead:
Why do people need cosigners?
As I mentioned above, cosigners can help people who have no credit or poor credit. While there are many ways to build credit, when you need a loan and you’ve got limited credit, a cosigner is your best bet.
Typically, cosigners are used by teens or young adults who are taking out college loans or signing a lease on their first apartment.
But cosigners are also used for people who need a loan on a car or even those who want to take out a credit card. Bank of America and Wells Fargo are two of the few who allow cosigners on credit cards.
By asking someone to cosign for you, the lender receives extra assurance that they’ll be repaid, even though you don’t have much proof in the form of a good credit history. It becomes a good starting point for you to prove that you’re creditworthy. Responsibly repaying a cosigned loan will also help you improve your credit score so you won’t need a cosigner next time.
What happens if the loan borrower fails to make payments?
The most important thing for a potential cosigner to know is that they will be responsible for payments on the loan if the person they sign for doesn’t pay.
So if you’re offering to be a cosigner but you don’t have the means to pay, this will negatively affect your credit score. It’s your credit history on the line if things don’t go well.
As a cosigner, your debt-to-income ratio will also increase. This is exactly what it sounds like—the percentage of your debt in relation to your income. An increased debt-to-income ratio won’t necessarily affect your credit score, but it’s best to keep your debt-to-income ratio as low as you can, especially if you hope to take out another loan (such as a car loan or mortgage) in the near future.
However, your credit score will reflect how much you owe and your total debt, so cosigning for a loan will affect that portion of your FICO score by increasing your total debt.
Finally, you’ll be included on the call and mailing lists if the debt goes to a collection agency. If worse comes to worst, the lender or debt collector can file a lawsuit against you for any unpaid part of the debt, even without suing the person you cosigned for.
That’s why you must be mentally and financially prepared to assume the total amount of the debt — even if you completely trust the person you’re cosigning for, sometimes things just don’t go as planned.
What to do if the person you cosigned for stops making payments
Sometimes, life just doesn’t work out. If you’ve cosigned for a trusted person but they are no longer able to or willing to make the payments, you have just a few options.
None of the options are ideal, but unless you talk with the borrower and convince them to somehow catch up on payments, you’re limited as to what you can do.
Pay the debt
As mentioned, you shouldn’t cosign a loan unless you have the means to pay the debt the borrower is taking on. If the borrower has fallen behind in payments, paying the debt yourself will be the first and most obvious choice.
However, that can be easier said than done. Plenty of people are cosigners who can’t get caught up on payments if the borrower has continuously missed them.
If you’re in that situation, you’ll need to get creative while you rustle up the money to repay the debt. Try looking for ways to make some cuts to your budget to try to free up some cash flow.
You could sell some belongings you don’t use anymore on an online marketplace. You’d be surprised at how quickly the dollars add up when you make a few sales.
Take on a few extra shifts at work, if that’s an option, to drum up more money to pay down the debt.
You could also give yourself some extra breathing room with one of your credit cards. A card like the Chase Freedom Flex℠ will give you a little extra buffer by giving you 0% Intro APR on Purchases for 15 months and on balance transfers. (After that, it’ll be 19.74% - 28.49% Variable).
A new cardholder bonus of $200 bonus after you spend $500 on purchases in the first 3 months from account opening. Plus, you can earn 5% cash back on bonus categories that you activate each quarter ($1,500 max spend per quarter allowed). You’ll also earn a generous 3% on dining and drugstores, and 1% on everything else. There’s no annual fee, but Chase will want to see good or even excellent credit to approve your application.
Don’t forget to keep your spending in check, even with a new card, so that you can continue to meet all your debt obligations.
Consolidate or refinance the loan
Another option is to refinance or consolidate the loan. This method also gives you the option to remove yourself or the borrower from the loan. However, the borrower might not have the credit necessary to refinance or consolidate on their own. You might instead choose to refinance it or consolidate it under your name only.
This might even give you a lower, more affordable monthly payment, because refinancing is essentially an entirely new loan, with completely new terms. You could wind up with a lower interest rate or longer loan term, which could effectively lower your monthly payments (and give you some breathing room, too).
Take a look at Credible if you’re interested in this option. Credible is a popular loan portal that lets you search for a new loan, including refinance loans, and they make it super simple to compare terms with real-time quotes.
To find possible refinance loans, fill out an application (it’s super short and simple) and let Credible know what kind of loan terms you’re looking for. When they deliver your search results, just compare the options: you can decide by APR, loan term, type of loan…and if you feel stuck, they have a Client Success Team who can give you real advice. Your new loan is not too far away: the lender you’ve chosen will need your financial docs and some personal info so they can pull your credit (a “hard pull”) and make sure you’re a good candidate for approval. If so, you could have a final offer in just one day.
Credible Credit Disclosure - To check the rates and terms you qualify for, Credible or our partner lender(s) conduct a soft credit pull that will not affect your credit score. However, when you apply for credit, your full credit report from one or more consumer reporting agencies will be requested, which is considered a hard credit pull and will affect your credit.Know when to say no to cosigning
Sometimes, a parent cosigning for their child is the only way to get a student loan. But if you’re in other situations where someone asks you to cosign a loan, it’s important to know when you should say no.
The risks of cosigning outweigh the benefits, no matter how honorable your intentions. Saying no to someone you’re close with may put a strain on your relationship for a while, but that’s nothing compared to what massive debt and ruined credit history will do to a relationship. Take a look at a few instances where you should say no to cosigning.
When you’ve got so-so credit
If your credit isn’t great, cosigning isn’t a good idea. Lenders are going to want to see good or even excellent credit, and if yours is just so-so, they may approve the loan…but with higher interest rates to compensate for their risk. If your borrower stops making payments, then you’ll be on the hook to cover them, and the high interest rates, too.
When you’ve got your eye on a new car
If you plan to take out a new loan in the near to medium future, cosigning for someone might throw a wrench in things. Cosigning won’t prevent you from getting a new car loan, but it will likely lower the amount you’ll be able to borrow — so you might have to downgrade that new SUV to an old sedan.
When you’re saving for a house
When you’re saving up to buy a house, it’s important to give yourself the best chance possible at a decent mortgage. Your lender is going to give all of your finances a complete once-over because a home is a very large purchase and they want to make absolutely sure you’re going to be able to pay it. If a new home is on your calendar, cosigning for a loan right now could put that in jeopardy.
When you can’t afford to cover the loan
Even if you trust the other borrower with your whole heart, if you can’t afford to cover the loan, don’t cosign. Life is too unpredictable. Your other borrower could be the most trustworthy person in the world, responsible to a fault, timely with every single payment, but all it takes is one catastrophe to turn someone’s world upside down. If you can’t cover the loan if something happens, don’t risk it.
Alternatives to cosigning
If you don’t feel comfortable cosigning a loan with someone, consider an alternative option.
Help the borrower find a different loan
One solution would be to assist the other borrower in finding a loan that works with their credit profile — without you needing to be involved in the transaction. Sometimes they might simply need a little more help researching loans.
Or, you could point them to a peer-to-peer lender, which might have more flexible requirements and allow them to get a loan that way.
Provide help in an emergency
Rather than cosigning a loan and making it official, you could provide your financial help without a signature. In other words, you can still help the other person cover payments if they’re in financial trouble, you just don’t have your name on the documents.
Help the borrower build credit and try again
If someone truly can’t get a loan without a cosigner, maybe it’s time they hold off on borrowing. Instead, suggest they work on building their credit to the point where a lender is fine with them signing on their own.
Opening a secured credit card is one way to begin building credit; just make sure the card reports to one, or preferably all, of the three major credit bureaus.
Summary
Being a cosigner is ultimately a personal decision, but it’s important to know the very real risks. You’ll be entirely responsible for any missed payments and you’re putting your credit history at risk if things go south. Before agreeing to cosign a loan, make absolutely sure you can bear the financial responsibility.
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