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What Happens When You Cosign On A Loan?

Cosign A Loan

A co-signer is a person who signs off on another person’s loan and agrees to pay off the debt should the borrower fail to pay for whatever reason. As a co-signer, you must have adequate income and a good credit score to assist the borrower to qualify for the loan. You are not entitled to the money or property that might be acquired once the loan is approved. A person might need a co-signer when he cannot qualify for the loan on their own as a result of various reasons such as:

  • Poor credit score
  • History of bankruptcy (READ: How To Rebuild Credit After Bankruptcy)
  • Lack of borrowing history
  • Not enough funds to cover the loan payments

Risks associated with co-signing

While you could agree to co-sign on a loan for a family member or friend out of your kindness, it does not mean that you’re exempted from the risks associated with the decision. Before putting down your signature on the dotted line, ensure that you fully understand the risks.

The loan becomes your responsibility

The lender expects you to be able to make full payments including any interests and fees should the borrower fail to pay. So, whether the borrower defaults intentionally or otherwise, the lender will use all means possible to collect the money from you. Before agreeing to co-sign, evaluate your finances to ascertain your ability to make the payments should the borrower be unable to.

Damage to your credit

The new loan will appear on your credit reports including details such as late or missed payments. Anything negative will not only affect the borrower, but it will also hurt your credit score. A bad credit score means it will be harder to get credit or you will be forced to pay high rates for things like insurance.

Your ability to acquire credit is impacted

When you co-sign a loan, you increase your debt-to-income ratio. A higher debt-to-income ratio could be an indicator to the lender that you’re a high-risk borrower. The credit could be denied or when given the terms might not be friendly. At the same time, co-signing lowers the total income you have available to make payments for any new loan you apply for.

Legal issues

You can find yourself fighting legal battles should the lender decide to sue you when several payments are not made on time by the borrower. The court might rule in the lender’s favor and you find yourself having to pay the entire debt and legal fees incurred.

Loss of property

Should you pledge personal assets like a car or house when co-signing for a loan, you can lose the property should the borrower default or you’re unable to make payments. The lender has the right to claim the property.

You’re stuck with the loan

Co-signing on a loan puts you in a long-term relationship with the lender who might not be willing to let you go. The only way you can be let go is when the borrower qualifies for refinancing or they get another co-signer or the loan is paid in full.

Broken relationships

The relationship between the borrower and the co-signer can break when the borrower defaults and fails to communicate to the co-signer until the situation has worsened. The lost trust is not easy to rebuild.

No ownership

You have rights to any assets or properties acquired with the loan money or are you expected to have control over the borrower spends the money on.

When is it alright for you to co-sign on a loan?

There are certain circumstances when co-signing on a loan especially that of an adult child, partner or close family member is a good idea such as:

  • You can afford the risk:

    If you’re sure that you can pay off the entire loan should the borrower fail to do so, then it’s in order if you co-sign on the loan. Evaluate all your assets and income to deal with any present and future eventualities.

  • The loan will benefit you both:

    only co-sign on a loan when you’re sure that it will benefit you too. For example, if the loan will be used to purchase a family car that you will be a co-owner.

  • You truly want to help the other person:

    when you trust and are aware of the other person’s financial status, then co-signing is a good idea.

Alternatives to co-signing

  • Help with the down payment:

    Offer to put a down payment on the loan to enable the borrower to get the approval needed. Agree with the borrower if the money is a gift or you expect it back in the future.

  • Lend the borrower the money:

    if you are liquid enough instead of co-signing. Have a written agreement of how the money will be paid back. The downside of this is that the relationship can become awkward when the borrower fails to pay.

  • Ask the borrower to put up their assets as collateral:

    instead of having you co-sign.

How to protect yourself as a co-signer

  • Talk to the lender about your responsibilities and how they’ll communicate to you regarding late or missed payments.
  • Stay in close contact with the borrower and get as much information as you can about repayments.
  • Request the borrower to grant you access to the loan account to enable you to track payments.
  • Get released: some lenders can allow you to be released once the borrower has met certain conditions.
  • Manage the risk: be wary of co-signing on loans of large amounts and which take a long time to be repaid. Co-signing on smaller short-term loans can help you protect your finances.

Check out our article on how to recover from bad credit, even if you’ve been dealing with bad credit your whole life!

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