SUMMARY: Learn what it means to cosign a loan and how it affects your credit. Understand the financial risks associated with cosigning and how to safely do it.
If you are asked to cosign a loan for a friend or family member, or if you are thinking of asking someone to cosign for you, there are some important things to consider before doing so.
What Does it Mean to Cosign a Loan?
When someone agrees to cosign a loan, this means they put their name on the loan, along with the primary borrower. The cosigner is fully responsible to pay back the loan should the primary borrower fail to make the payments. Borrowers usually need a cosigner when their credit is not strong enough to get a loan on their own. The borrower uses the cosigner’s good credit to secure a larger loan or a better interest rate. Often, young people who have no credit history need cosigners to secure a car loan or student loan.
While it feels great to help out a loved one, there are risks associated with cosigning. It is also important to understand that cosigning is different from a joint loan, as the cosigner has no right to the loaned money, even though they could be responsible for repaying it.
Does Being a Cosigner Affect Your Credit?
Many people are confused about how a cosigned loan can affect their credit. A cosigned loan will appear on both the primary borrower and the cosigner's credit reports. If you are the cosigner, the loan could affect your credit in several ways.
- Initially, your credit will take a small hit, simply because the creditor does a hard pull on your credit to approve the loan.
- Your debt-to-income ratio will increase, which could make it harder for you to get a loan for yourself down the road.
- Your credit could be ruined should the primary borrower fail to make the payments in full and on time.
- Your payment history will improve if the primary borrower makes all of the payments, as agreed upon.
How to Cosign a Loan and Protect Your Credit.
So, does cosigning hurt your credit? The answer is: not necessarily, but there are a few things you should do to protect yourself before making a commitment.
- Don’t cosign for someone you do not know well, or who you know to be irresponsible with money.
- Get online access to the account so you can regularly check the status without having to ask your loved one constantly.
- Arrange for the lender to notify you immediately when payments are past due.
- Make sure you have enough money set aside to make the payments should the primary borrower fail to do so.
- Consider your own financial goals and how cosigning may affect your ability to save money or get a loan in the future.
Cosigning a loan can be a wonderful gift to give someone you love, as long as you weigh the risks and plan ahead.
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