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When an applicant's credit doesn't qualify them for a loan, finding a cosigner with good credit can help get the loan approved. Cosigning a loan may seem easy—all it takes is a signature, after all—but cosigning a loan is a serious commitment with serious consequences if things go off track.
If you're thinking about cosigning to help a family member or friend secure a loan, review the pros and cons of cosigning first, both on your own and with the person looking to borrow. By fully understanding what you're signing up for, you may avoid potential problems down the road.
How Does Cosigning on a Loan Work?
When you cosign a loan, you're adding your good name (and good credit) to the loan application and agreeing to bear equal responsibility for the account. You agree to make payments if the borrower can't—or won't. Cosigning a loan means the loan will appear on your credit report. You're also putting your credit on the line if the borrower makes late payments, and you may also be on the hook for late payment fees.
Meanwhile, cosigning a loan does not entitle you to any of the loan's proceeds. You don't have an ownership stake in property purchased with the loan, either.
Pros of Cosigning a Loan
Most of the benefit for cosigning a loan goes to the borrower, who may be able to take out a loan and secure a more favorable interest rate by adding a cosigner to their loan application.
However, there are a few perks for you, the cosigner:
You'd Be Helping Someone in Need
The primary benefit of being a cosigner is helping a friend or family member in need. For example, you want to help your kids get a start in life or help a friend re-establish credit after going through a difficult financial time. Cosigning a loan for someone you love could make it possible for them to buy their first home, buy a much-needed car or refinance high-interest debt at a more affordable rate.
It Could Help Improve Your Credit
Cosigning can have a positive effect on your credit, as long as the loan is repaid successfully. Because you're equally responsible for the loan, the account will add to your credit report. On-time payments will contribute to your payment history and the presence of the loan could improve your credit mix, which could reflect positively on your credit.
Cons of Cosigning a Loan
Cosigning a loan can also have negative implications for your credit and borrowing power, regardless of whether payments are made on time. Additionally, if you run into trouble, your relationship with your friend or family member can suffer.
Here's a quick rundown of potential pitfalls for cosigners to consider:
It May Hurt Your Credit
Any problems the borrower has with the loan may be reflected on your credit report, including late payments, collections and repossessions. Any of these can lower your credit score, and may stay on your credit report for seven years.
If you're thinking about cosigning a loan, you may want to check your credit reports and score beforehand: You'll need good credit to be an effective cosigner. You may also want to consider credit monitoring, so you'll be alerted to changes in your credit file when they happen. That way, if problems begin popping up, you can address them early on with the borrower.
You May Limit Your Borrowing Power
Lenders compare the total amount you earn each month to the total amount you owe—your debt-to-income ratio (DTI) —when considering you for a loan or credit. Monthly payments for loans you cosign are included in this calculation. Even if you're not making the monthly payments on a cosigned loan, it can affect your borrowing power as if you are.
You May Have Trouble Opting Out
Removing yourself from a loan you've cosigned can be difficult. Lenders may need to re-qualify the borrower using their own credit in order to remove your name from the loan. Alternatively, the borrower may have to refinance or pay off the loan to extricate you from the arrangement.
You May End Up Paying the Loan Yourself
If your friend or family member can't repay the loan, you are on the hook. Depending on the loan amount and how much has already been repaid, this could mean taking on an additional mortgage payment every month—or assuming a mortgage-sized debt.
You May Strain Your Relationship
Having to take over monthly loan payments and/or a large debt puts an obvious strain on a relationship. But even if problems never come to this, cosigning may add a level of dependency that's problematic. You may (justifiably) worry about the borrower's financial status and whether they're paying their bills on time. If your loved one misses a payment by mistake or runs into financial difficulty, you may feel angry or betrayed—adding to the stress of an already tense situation.
Should I Cosign a Loan?
Consider the contractual pros and cons of cosigning, but also think about your ability to take on additional financial responsibility and risk. Weigh the strength of your relationship with the borrower and how comfortable you are carrying a shared responsibility for debt.
Before signing onto any loan, ask yourself these questions:
Can the Borrower Repay Their Loan?
Lenders use credit scores, credit history and other information from a borrower's loan application to size up their ability to repay. As a cosigner, you may want to do your own evaluation. Think beyond good character (which should be a given) and consider whether they have the reliable means to make their payments and pay off the loan.
Do Both of You Understand the Ramifications of Cosigning?
Discuss with the primary borrower the potential consequences of cosigning, including the effects on your credit, financial risks to you if they default and what these problems would mean to your financial wellbeing. Review the loan agreement together so you're both clear on how cosigning will work.
What Happens if They Can't Make a Payment?
You may want assurances that they'll reach out for help before a payment is past due, so you can both avoid late fees and late payments on your credit reports. If they're not able to continue making payments on the loan, then what? Will they be prepared to sell their home, for example, if their cosigned mortgage is unsustainable? Will they make a repayment arrangement with you?
How Risky Is Cosigning for You?
Suppose you're forced to repay the loan yourself. Can you afford the payments? Will it cause genuine financial hardship? In addition to discussing these risks with the borrower, think them through on your own. Cosigning a loan can be a real help to credit-challenged loved ones, but you shouldn't have to put your financial health at risk.
The Bottom Line
In the end, helping someone take out a loan they can't afford or take on a responsibility they aren't ready to meet isn't really helping. If you're thinking about cosigning a loan for a family member or friend, tread carefully. As a cosigner, you should feel confident in the borrower's ability to repay and have open lines of communication with them during the repayment process. Make sure you aren't putting yourself in financial jeopardy.
If you do decide to cosign, give yourself some credit. By extending a hand and agreeing to vouch for your friend or family member, you're giving them the opportunity to build their credit—and financial future.