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When you agree to be a cosigner on a loan for someone, you're essentially vouching for that person. In most cases, you'll be asked to cosign for a friend or family member who couldn't get approved for financing on their own. If they stop making payments, the responsibility will be passed on to you—and you could be sued if you don't follow through. Your credit could also suffer.
Understanding what you're getting into can help you decide if being a cosigner is worth the risk. Let's unpack what happens to the cosigner when default occurs, along with steps you can take to prevent it from happening.
You're Responsible for Paying the Debt
When someone applies for a credit product, they must meet the lender's eligibility requirements to get approved. A poor credit score or thin credit file could prevent them from getting the green light. When a cosigner with strong credit steps in, it can strengthen their application. The cosigner shares equal responsibility for the debt and promises to make payments if the borrower falls behind or defaults.
Cosigners can be used on student loans, mortgages, credit cards, auto loans and more. For example, roughly 92% of private undergraduate student loans for the 2021-2022 academic year had a cosigner, a study by MeasureOne, a data analytics company, found.
What Happens to a Cosigner if the Borrower Defaults?
Cosigned accounts will show up on your credit report. If the primary borrower repays their debt as agreed, that positive payment history can strengthen your credit score. The opposite is also true, however. And if they default, you will be required to make payments on the borrower's behalf. Here are the consequences you could face if you fail to do so.
- Your credit score could take a hit. Missed payments remain on your credit report for seven years. Your payment history also makes up 35% of your credit score, so keeping your accounts in good standing is important to your overall credit health. This is especially true if you seek financing in the future. Having a delinquency on your credit report could make it difficult for you to get approved for new accounts going forward.
- You could be sued. If the account goes unpaid for long enough, the lender could hire a collection agency to help them seek payment. The debt collector or lender may choose to sue you as the cosigner for the unpaid balance, causing you to rack up thousands in attorney fees and court costs on top of the debt that's owed.
- It could put a strain on your finances. If the primary borrower is struggling and you assume the payments, it might impact your cash flow. This could make it harder to pay your bills or prevent you from making progress toward your financial goals.
- It could damage your relationship with the borrower. If things go sideways and the borrower misses their payments, you may feel resentful. This could end up hurting your relationship, especially if your financial health is damaged in the process.
Steps to Take if You Can't Make the Payments
If a default occurs and you're unable to take over the payments, there may be ways to protect your financial well-being.
- Ask the primary borrower to refinance the debt. One option is to see if the borrower can refinance the debt into their own name. This would effectively remove you from the account. It requires them to take out a new loan on their own, then use that money to absorb the joint debt and close the original account. The borrower will need to meet the eligibility requirements for a debt consolidation loan, so their credit score and financial health will come into play.
- Seek forbearance. This temporarily reduces or pauses loan payments due to a borrower's financial hardship. The lender will likely conduct a financial review before granting forbearance. If approved, it could provide relief for up to 12 months. If the debt in question is a federal student PLUS loan, you might also seek an income-driven repayment plan.
- Consider credit counseling. Nonprofit credit counseling provides free or low-cost financial resources, like help with budgeting and advice for managing debt. In some cases, a credit counselor may recommend a debt management plan. The National Foundation for Credit Counseling or the Financial Counseling Association of America are good places to start your search for a credit counselor.
How to Avoid Loan Default as a Cosigner
Here are some ways to protect your financial health and prevent a default if you decide to be a cosigner.
- Ask the lender if you can be released from the loan. They may agree to drop you from the account after the borrower makes so many positive payments in a row. Be sure to understand the rules before agreeing to cosign.
- Keep in contact with the borrower. Make sure the borrower is comfortable with the monthly payment amount. If they do stumble on hard times, ask them to communicate that to you as soon as possible.
- Routinely check your credit report. This should show you the outstanding loan balance and if there are any late payments or delinquencies on record. If so, you can take action sooner rather than later.
- Communicate with the lender. They may agree to send you monthly statements and let you know if the borrower misses a payment. This can prevent unwanted surprises down the road.
- Understand your rights. The Federal Trade Commission suggests checking with your attorney general or state banking agency to see if any extra cosigner protections are in place. If a borrower defaults in Michigan, for example, the lender cannot report adverse information about the cosigner to a credit reporting agency until they've notified them of the default and waited at least 30 days for them to make an acceptable payment arrangement.
The Bottom Line
Becoming a cosigner for a friend or family member could help them access much-needed financing, but it isn't without risk. If you cosign, you are legally responsible for the debt should the primary borrower default on their payments. Regularly checking your free credit report with Experian is a simple way to see if the account you've cosigned is in good standing. Beyond that, keeping in contact with both the borrower and lender can help you avoid financial surprises.