In a Nutshell
Think twice before you agree to co-sign a loan. Co-signing can put you at real financial risk and seriously damage a relationship.Co-signing a loan is a significant financial decision that can help a friend or family member secure financing, but it also comes with a serious set of risks and responsibilities.
If you’re considering co-signing a loan, it’s crucial to understand what you’re getting into. In the simplest terms, co-signing means you’re agreeing to take on the responsibility of someone else’s loan if they can’t make the repayments. It’s a generous act, but it comes with potential hazards.
So whether you’re thinking about co-signing a loan or just curious about the process, keep reading to get a better understanding of what’s involved.
- What is co-signing?
- Benefits of co-signing a loan
- Risks of co-signing a loan
- Alternatives to co-signing
- Protecting your credit when co-signing
- Building credit through co-signing
- FAQs about co-signing a loan
What is co-signing?
Co-signing a loan is a commitment that should not be taken lightly. It involves agreeing to take on the responsibility of a loan if the primary borrower cannot make the repayments.
Defining co-signing and its purpose
Co-signing is a practice used by lenders to help secure loans for people who may not have a strong credit history or sufficient income. By having a co-signer with a good credit score and steady income, the lender more confidence that the loan will be repaid, even if the primary borrower defaults.
This can benefit the borrower, who may be able to secure a loan with better terms than they would otherwise qualify for.
As a co-signer, you’re essentially vouching for the borrower’s ability to repay the loan, and if they fail to do so, you’re on the hook to pay.
Co-signing vs. joint loans
Co-signing a loan is not the same as having a joint loan. In a joint loan, both parties are primary borrowers and share equal responsibility for the loan from the start. They both have equal rights to the property or item purchased with the loan and are equally affected by the loan’s impact on their credit scores.
In contrast, a co-signer only becomes responsible for the loan if the primary borrower defaults. The co-signer does not have any ownership rights to the property or item purchased with the loan, but their credit scores can be affected if the primary borrower fails to make payments.
Typical scenarios for co-signing
Co-signing is often considered in situations where the primary borrower is a student with no credit history applying for a student loan or a first-time car buyer who needs an auto loan but lacks a credit history.
It can also be a consideration when someone is trying to rebuild their credit after a financial setback, such as bankruptcy or foreclosure. In these scenarios, having a co-signer can make the difference between being approved or denied for a loan.
Benefits of co-signing a loan
Co-signing a loan allows you to help someone secure a loan that they may not have been able to obtain on their own.
Additionally, if the borrower makes their payments on time, it can help both parties build a positive credit history. This can be particularly helpful for the primary borrower, who may be trying to establish or rebuild their credit.
For the co-signer, it can provide a sense of satisfaction in helping someone they care about achieve their financial goals.
Risks of co-signing a loan
Co-signing a loan comes with significant risks. As a co-signer, you’re legally responsible for the loan if the primary borrower can’t make the repayments. This can affect your credit scores, increase your debt-to-income ratio and potentially lead to legal action if the loan isn’t repaid.
It’s also important to note that as a co-signer, your credit could be affected even if the primary borrower makes all their payments on time. That’s because the amount of the loan is considered part of your overall debt, which can affect your credit utilization ratio and potentially lower your credit scores.
Alternatives to co-signing
Before agreeing to co-sign a loan, you may want to consider other options. For example, the borrower could apply for a secured loan or a credit-builder loan, which may be easier to obtain and carry less risk for you.
A secured loan requires collateral, such as a car or house, which reduces the risk for the lender and can make it easier for the borrower to get approved.
A credit-builder loan, on the other hand, allows the borrower to make payments to a savings account for a set period of time, and then gives them the money once they’ve completed all the payments. This can be a good way for someone with poor or no credit to build a positive credit history. You might also want to consider Credit Karma’s Credit Builder plan, which can help you build low credit while you save.
Protecting your credit when co-signing
If you decide to co-sign a loan, it’s important to take steps to protect your credit. This could include setting up online account access to monitor the loan, arranging for the lender to notify you if payments are overdue, and setting aside money to cover any missed payments.
It’s also a good idea to have a candid discussion with the primary borrower about the importance of making their payments on time and the potential consequences if they fall behind on their payments.
Building credit through co-signing
While co-signing a loan can help your friend or family member build credit, it’s important to remember that this shouldn’t be the sole reason for co-signing. The risks associated with co-signing a loan can outweigh the potential benefits to the primary borrower.
Next steps
Before co-signing a loan, it’s crucial to fully understand the risks and responsibilities involved.
If you’re still on the fence, remember that co-signing a loan is a significant commitment that can have long-term effects on your financial health. Before you act, you might consider reaching out to a financial advisor who can provide personalized advice based on your financial situation.
And don’t forget to explore alternatives to co-signing, such as secured or credit-builder loans. Learning more about managing your money can help you make decisions that benefit your long-term financial health.
FAQs about co-signing a loan
Removing yourself as a co-signer can be difficult and typically requires the primary borrower to refinance the loan in their own name. This means they would need to qualify for the loan on their own, which may not be possible if their credit or income hasn’t improved since the original loan was taken out.
As a co-signer, you may have to pay late fees or collection costs if the primary borrower doesn’t pay their debt. It’s also worth noting that if the account goes into collections, the lender could seek to garnish your wages.
If the person you co-signed for doesn’t pay, you’re legally responsible for the loan. This could result in late fees, a hit to your credit score and potential legal action from the lender. If the loan goes into collections, it could also lead to calls from debt collectors. In some cases, the lender may even have the right to garnish your wages or take other legal action to recover the debt.
*Approval Odds are not a guarantee of approval. Credit Karma determines Approval Odds by comparing your credit profile to other Credit Karma members who were approved for the personal loan, or whether you meet certain criteria determined by the lender. Of course, there’s no such thing as a sure thing, but knowing your Approval Odds may help you narrow down your choices. For example, you may not be approved because you don’t meet the lender’s “ability to pay standard” after they verify your income and employment; or, you already have the maximum number of accounts with that specific lender.