From individuals with less-than-stellar credit scores to young adults with thin credit to otherwise responsible borrowers with piles of emergency debt, there are plenty of cases where one might benefit from a loan in a huge way—but don’t have the credit to qualify.
Adding a cosigner can be a simple way for folks in situations like these to access funding. But it can create a whole new problem for the cosigner. It’s a great tool when used wisely, but it also comes with risks that you may not have considered. Here’s what you need to know before offering to cosign a loan.
What does it mean to cosign a loan?
When you cosign a loan, you’re agreeing to repay the money borrowed by the one taking out the loan. In other words, if the borrower fails to make payments, you’re on the hook for them. If you don’t, your credit will tank alongside the primary applicant.
Lenders may require a cosigner for anyone trying to open a loan with an inadequate credit profile. If their credit score is low, or if there’s another concerning factor that makes the financial institution’s palms sweat at the thought of lending money to an individual, adding a cosigner with good credit may be the only way to get the deal done. The lender will then examine the cosigner’s credit and income and make a decision off that information.
It’s worth noting that a cosigner is different from a “co-borrower.” Cosigners have no right to use the funds themselves; they’re just on the contract to guarantee that the loan will be repaid. A co-borrower, on the other hand, shares the ownership of the loan.
How does cosigning affect your credit score and debt-to-income ratio?
When you apply to cosign a loan, the lender will usually initiate a hard inquiry on your credit. This gives them an idea of how trustworthy of a borrower you are. Hard credit inquiries can temporarily drop your credit score by a few points, but they generally bounce back quickly with responsible credit usage.
However, your debt-to-income ratio (DTI) will increase when you cosign a loan. That’s because the loan’s monthly payments factor into your DTI. This can make it harder to qualify for your own loans (think credit cards, mortgages, auto loans, etc.) in the future. As long as the loan is open, you’ll feel that impact.
Pros and cons of being a cosigner
Pros
- Simple way to help someone with thin or poor credit to establish a solid credit profile
- Helps a loved one qualify for a loan when they otherwise couldn’t
- Primary borrower can potentially receive better interest rates than if they had applied solo
Cons
- Loan repayment is ultimately your responsibility
- Increases your debt-to-income ratio which can lower your ability to borrow until the loan is repaid
- Failure of the primary applicant to make payments can result in damaged relationships
5 under-the-radar risks of cosigning a loan
Aside from the obvious risks of cosigning a loan—being on the hook for payment if the primary applicant fails to do so and sharing the blame for delinquency if the loan defaults—there are a handful of more insidious risks to watch out for. Consider the following before you volunteer as a cosigner.
It’s typically hard to remove yourself as cosigner
Removing your name from a loan before it terms is often extremely difficult (or even impossible). Many loan types offer no cosigner release option, and those that do not guarantee the result.
For example, some auto loans advertise that a cosigner can be removed from an account after a set number of on-time payments. But depending on your specific lender and financial situation, this may not be an option. Your only solution may be for the primary borrower to refinance the loan solely in their own name once their credit profile improves.
Bankruptcy of the primary borrower doesn’t absolve you
If the primary applicant defaults on the loan, they may file bankruptcy to discharge their unsecured debt. That can remove their responsibility for repaying the loan. But as a cosigner, that’ll do you no favors. You’re still on the hook for repaying the full balance unless you also file bankruptcy.
To boot, you may have to repay the entire loan amount immediately if the primary applicant files bankruptcy. That’s quite the gut punch, especially if you entered into the loan with the assumption that you’d never have to contribute a dime.
Lenders may target you for payment before the primary borrower
When a payment is missed, financial institutions may attempt to collect payment from the cosigner before the borrower. You could find yourself being hounded with collections, lawsuits, even wage garnishment.
It can complicate other financial goals—including retirement
Because lenders count the full cosigned loan toward your DTI, you may have a tough time achieving other financial objectives. For example, most lenders want you to have a DTI at or below 36% when refinancing a mortgage. Cosigning a large loan may push you over this threshold, even if you never have to pay the installments.
You may also have trouble cosigning elsewhere if necessary, as it could send your DTI through the roof.
Again, your DTI may not feel like it’s being strained if your cosigner faithfully pays their monthly bill , so it’s a less apparent disadvantage—until you’ve got an important application of your own to fill out.
It can strain personal relationship under pressure
Less financially crippling but perhaps riskier overall is the potential relationship issues that can arise from cosigning a loan. Tying your credit profile and the wellbeing of your finances to someone else takes incredible trust. If the borrower falls behind, that can create lasting tension with friends or family members.
When does cosigning a loan make sense?
Again, cosigning a loan can make sense if you’re working with an extremely trustworthy borrower. They should have a perfectly realistic repayment plan and borrow well within their means. Review the loan terms with them to ensure they can comfortably make the monthly installments.
All to say, you should only cosign with someone you are absolutely certain will stay current on the loan, and you should also be capable of handling a worst-case scenario of repaying the loan in full yourself.
Alternatives to cosigning a loan
There are ways to extend financial help to someone without taking legal responsibility for their debt. For example, you could:
- Help the would-be borrower build their credit to qualify for their own loan. This could mean adding them as an authorized user on your credit card, pointing them toward a credit-builder loan, etc.
- Skip the banks and lend as much as you can in a written agreement. Then at least if they are behind on a payment, your credit profile isn’t affected.
- Offer a smaller cash gift or contribute to a down-payment (depending on the reason for the loan)
The takeaway
Cosigning a loan can be a great way to give a family member or friend a much-needed boost toward their financial goals. But it can hamper your own goals if you’re not cautious.
In addition to taking legal responsibility for the full loan amount, your debt-to-income ratio will increase. Be sure the primary applicant’s trustworthiness is above reproach, or you could find yourself in financial straits with no loan funds to show for it.
Frequently asked questions
Can cosigning prevent you from getting a mortgage or car loan?
Yes, cosigning can potentially make it harder for you from getting a loan down the road like a mortgage or car loan. That’s because your debt-to-income ratio increases as though you were the one borrowing the money.
Does cosigning a loan affect your credit score?
Cosigning can affect your credit score when you open it, as your credit will sustain a hard credit inquiry. It should bounce back soon as long as you continue to exhibit responsible credit habits. The biggest way your credit may be impacted is if the primary borrower lets the account slip into delinquency. If the account owner doesn’t make the monthly payment, it’s up to you to do it.
How long do missed payments on a cosigned loan stay on your credit report?
Missed payments on a loan—cosigned or not—can stay on your credit report for up to seven years from the delinquency date.
What happens to a cosigner if the borrower dies?
If a borrower dies, the impact on the cosigner will vary depending on the type of loan that was taken out. Some may be discharged, while others may require full payment immediately.
Can you remove yourself as a cosigner from a loan?
You generally can’t remove yourself as a cosigner from a loan. Some loans offer cosigner release options if certain criteria are met—such as the borrower’s credit improving or a specific number of on-time payments made—but you won’t typically find any cosigner release guarantee.