If a borrower needs help getting a loan, a cosigner can improve their chances. If a person has a poor credit history, no borrowing history, or is recovering from a difficult financial situation, a cosigner helps assure lenders that the loan will be paid back. A cosigner will typically have a strong credit score, higher income, and lower debt-to-income ratio than the borrower — this increases the likelihood that the lender will approve the loan.
Anyone over 18 can be a cosigner as long as they have a good credit history and are willing to cosign for the borrower. The lender will also vet the cosigner in the application process. Keep reading to learn more about cosigning a loan.
How Does a Loan Affect a Cosigner?
Before you decide to cosign, you need to understand the implications that come with it. While you may see it as helping out a friend or family member in need, your responsibility doesn't end once you've signed. You take on the responsibility of paying back the loan, too.
Benefits of Cosigning a Loan
One of the main pros of cosigning a loan is that you can help someone qualify for a loan they would not be able to get on their own. When lenders see that a cosigner has a good credit history and a high income, they are more likely to grant the borrower a loan. It can also help them get better interest on the loan. The borrower may also be able to get a larger loan with a lower annual percentage rate (APR), which is the number that represents the total yearly cost of borrowing the money.
Having a high credit score and income when you're a cosigner may benefit the borrower because they can get more funds and pay less interest. If they have very little or poor credit history, cosigning on a loan can help someone build up their credit or rebuild their history. As long as they make payments on time, the account will build a positive payment history and boost their credit.
If you have a good credit score and a sound credit history, it can make a big difference in helping someone get a personal loan. Cosigning can also help to build your credit — it does this in two ways:
- If the borrower makes payments on time, it adds to your own payment history. If you already have a high credit score and well-established credit, the benefit of these payments on your credit score may be minute compared to the amount of risk you are taking in the event that the borrower doesn't pay.
- If the loan improves your credit mix, it can benefit your credit, too —your credit benefits from having a combination of accounts such as installment loans, retail accounts, and credit cards.
Disadvantages of Cosigning a Loan
When you cosign for someone, you put your own credit and finances at risk. If the borrower misses a payment or defaults on the loan, the lender will turn to you to set things right. You'll be responsible for paying the outstanding balance.
Depending on the payments that the borrower does or doesn't make, it will go on your credit report. If the borrower defaults on the loan, the bank will contact you to make payments, but at this point, the damage will have already been done. You'll need to make the payments to prevent harming your credit further. If you can't pay back the loan either, the lenders or collectors could sue you, garnish your wages, or place a lien on your property to recover the debt.
Consider your relationship with the borrower because you'll be tied to them throughout the loan. They may face financial difficulties where you'll be forced to step in to protect your credit. Even if your relationship changes, you'll still be tied to them financially.
Cosigning can also limit your borrowing power, making it difficult for you to get a loan when you need one. When you apply for a loan, lenders look at your debt-to-income ratio. Depending on how much debt you already have, consigning will make it seem like you have more debt than you can handle. Lenders may reject your loan application if they believe you won't be able to pay back the loan.
If you change your mind, removing yourself as a cosigner can be difficult. You'll be tied to the loan agreement unless the borrower qualifies for refinance, assumes the loan without you as a cosigner, or decides to close the loan. You can also remove yourself by getting a loan release from the lender — an official document stating the borrower can take the loan independently. Only a few lenders offer a loan release, though.
Deciding Whether to Cosign a Loan
Before you cosign a loan, you should take a few actions to safeguard yourself. Ensure you can afford the loan payments if something goes wrong — you'll be responsible if the borrower defaults on the loan. It's also wise to save money if the borrower can't make payments.
Discuss the borrower's financial situation and ability to pay back the loan. The borrower should be in a financial position to make regular payments. Avoid cosigning for someone you know is financially irresponsible or is taking on more debt than they can handle.
You and the borrower should have a plan for how you will communicate about the loan. Make sure you have online access to the account. The borrower must notify you if they miss a payment and let you know if they decide to close the loan or refinance.
Be part of the application process and discuss the agreement with the lender and borrower so you clearly understand each party's obligations. It's important that you review the paperwork and that you're a part of the agreement process. You can also influence the contract conditions, especially the ones relating to cosigning release. If communication breaks down between you and the borrower, it's essential that you also have a copy of the contract to deal with any disputes.
If you don't decide to cosign, sympathetically and clearly communicate the financial risks and responsibilities that helped make your decision. Explain to the other person the responsibility and risk you would be taking if you did cosign — some people don't understand the risk of cosigning. You can also approach the conversation with some alternatives to cosigning, such as:
- An alternative loan: You can find a lender with a loan option for first-time homeowners or borrowers with a mixed credit record.
- A more affordable option: They may have to choose a home or car that requires a smaller loan.
- A student loan: If the borrower needs money for educational expenses, they can take out a student loan that doesn't require a cosigner.
- Waiting: If the loan isn't urgent, the borrower may be able to take out the loan on their own if they wait a few years.
Apply for a Loan From Atlas Credit
Cosigning for a loan is a big responsibility. You'll need to ensure the borrower is financially ready and responsible enough to take on the loan. Cosigning can help someone close to you access the funds they need to achieve a big milestone, like buying their first home or getting back on their feet.
It will impact your credit history if they struggle to repay the loan. Clearly communicating with the borrower and lender and understanding the agreement's implications and terms can help set you and the borrower up for financial success.
At Atlas Credit, we make the personal loan application process easy with a secure online application. Our easy payment options make it simple for borrowers to stay on top of their monthly payments. To learn more, apply for a personal loan today!
