What You Need To Know As A Co-Signer

by Kiah Treece

Forbes Advisor

Tuesday April 13, 2021

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Stock image  (Source:Getty Images)

If you've been asked to co-sign on a loan, it's vital to first understand how co-signing works and what your responsibilities will be under the arrangement. While you'll only have to make loan payments if the primary borrower defaults, being a co-signer does come with certain risks — late payments can negatively impact your credit score, and you may be on the hook for the full loan amount.

To help you make the right decision, we'll walk you through this loan term, including the process of co-signing on a loan, possible risks and tips for protecting yourself.


What Is a Co-signer?

A co-signer is someone who helps a prospective borrower — typically someone with poor credit or no credit — qualify for a loan by pledging to repay the loan if the borrower does not; the lender typically relies more heavily on the co-signer's credit score during the application process. Co-signers do not have any ownership rights in the assets purchased with the loan and are not responsible for making monthly payments unless the primary borrower defaults.

Co-signer vs. Co-borrower

In contrast to co-signers, co-borrowers are typically reserved for situations in which both parties will receive a direct benefit from the loan. Therefore, co-borrowers share responsibility for repaying the loan and have equal rights to use the assets purchased with the loan. For example, co-borrowers on a home mortgage are typically both on the title; a mortgage co-signer will only be on the mortgage documents — not listed as an owner on the deed.


How a Loan With a Co-signer Works

Borrowers who need a co-signer typically do not have a credit score sufficient to qualify for a loan on their own. In this case, a more creditworthy friend or family member promises to repay the loan if the primary borrower fails to do so. This reduces the lender's exposure to risk because the loan is more likely to be repaid.

During the application process, both the primary borrower and the co-signer are required to submit documentation of income — including W-2s, 1099s or pay stubs — as well as contact information for employment verification. The lender also will run a hard credit check on both parties, which will show up on credit reports and remain there for up to two years.

Once the lender disburses the loan and the borrower begins repayment, a co-signer won't have access to the funds or assets and won't have to make payments. However, if the borrower fails to make on-time payments, these late payments will reflect on the co-signer's credit report and she will have to make payments or, in the case of default, work with a collections agency to pay off the loan entirely.

If a co-signer wants to be removed from the loan, she may have trouble doing so. In some cases, a co-signer can work with the lender to be removed from the loan or be dropped after a certain number of on-time payments by the primary borrower. Typically, though, the best way to remove yourself as a co-signer is for the borrower to refinance the loan without the co-signer.


When Should You Agree to Co-sign a Loan?

The decision to co-sign on a loan is difficult and should only be made under certain conditions. Only agree to co-sign a loan if you:

  • Have a strong credit score that will help the borrower qualify for a low interest rate
  • Don't plan to take out a loan for yourself in the near future
  • Aren't building your credit score, saving or otherwise preparing to buy a home
  • Completely trust the borrower and have evaluated his ability to make payments
  • Can afford the risk of paying off the loan if the borrower fails to make payments
  • Have evaluated alternatives to co-signing, like helping with a down payment or lending the money yourself


    Risks of Co-signing a Loan

    If you're considering becoming a co-signer, consider these risks before signing on the dotted line:

    1. Co-signers Are Responsible for the Entire Loan Amount

    Co-signers don't have access to the loan funds or assets and collateral purchased with those funds. However, they are responsible for repaying the loan balance if the borrower fails to make payments. This means that a co-signer's contact information will be forwarded to a debt collector in the case of the borrower's default, and a debt collector can sue a co-signer for repayment of a loan.

    2. Poor Payment History Will Negatively Impact Your Credit Score

    Even in the absence of default, late payments by the primary borrower will also negatively impact the co-signer's credit score. Payment history accounts for 35% of a borrower's FICO credit score, and late payments can stay on a credit report for up to seven years.

    3. You May Have Trouble Qualifying for a Loan in the Future

    Co-signing on a loan results in a higher debt-to-income (DTI) ratio and an increased amount of outstanding debt. A high DTI can make it difficult to qualify for loans, and the amount of a borrower's outstanding debt accounts for 30% of her FICO credit score.

    4. Your Relationship With the Borrower Could Be Strained or Damaged

    In addition to damaging your financial health, co-signing on a loan can negatively impact your relationship with the borrower. Even if you and the borrower enter a co-signing arrangement with the best intentions, it's impossible to predict how a borrower will handle payments and whether his finances will remain stable for the full term of the loan.

    5. It Can Be Difficult to Remove Yourself as a Co-signer

    Removing yourself as a co-signer is more difficult than adding yourself because it exposes the lender to greater risk. In general, the best way to remove yourself as a co-signer is for the borrower to refinance without your help. However, this may not be possible — especially if the borrower's credit score hasn't improved since applying for the original loan.


    Tips for Becoming a Co-signer

    Whether you're deciding to co-sign or are already named on someone's loan, protect your interests by following these tips:

  • Make sure you trust the borrower before committing to a co-signing arrangement
  • Take time to ask the borrower questions about his financial situation and plans for repaying the loan
  • Only serve as a co-signer if you're capable of making the loan payments yourself
  • Check your credit score regularly to ensure the borrower is making on-time payments
  • Ask the lender to contact you if the primary borrower fails to make an on-time payment
  • Maintain open communication with the borrower so you know if they anticipate trouble repaying the loan


    Alternatives to Co-signing a Loan

    If you're uncomfortable co-signing a loan but still want to help, don't despair. There are other ways to help borrowers build credit and access funds without putting your own credit score on the line. Consider these alternatives to co-signing on a loan:

    Find Financing Elsewhere

    The process of shopping for a loan can be challenging — especially for someone with a low credit score. If the prospective borrower needs a co-signer to qualify for a loan, he may just need help looking for a lender with less rigorous lending requirements. Start by researching personal loans for bad credit and take advantage of the prequalification process to see what's available without a co-signer.

    Help With a Down Payment

    In some cases, a larger down payment can be enough to put a lender at ease when dealing with a borrower who has poor credit. If this is the case, consider lending or giving the borrower cash to put towards the down payment rather than acting as co-signer.

    Help the Borrower Build Credit

    If the borrower doesn't need the funds immediately, consider helping him improve his credit score in other ways. This may involve taking time to review his credit report, explaining what makes up a credit score and identifying areas for improvement. If there are any errors on the report, help the borrower submit a dispute online in an effort to improve his score more quickly.

    You can also provide the cash necessary — or help the borrower save the cash — to take out a secured credit card. Though this may not solve the prospective borrower's immediate financial needs, it's still a great way to help build his credit history without putting your score at risk.

    Lend the Money Yourself

    Finally, if you have enough cash on hand and trust the borrower's ability to repay the sum, lend the necessary money yourself. Only go this route if you're financially stable enough to cover your own debts, comfortably plan for your own financial future and help the borrower. And if you do decide to go this route, put the agreement in writing so everyone is aware of the interest rate, loan term and other relevant repayment details.

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