If you have solid credit and steady finances, there’s a chance you may be asked to co-sign for a friend or family member’s loan at some point in life.
It could be to help them purchase a house, buy a car, or even just take out a personal or student loan. Either way, having you on the application can increase your loved one’s chances of approval — especially if they have poor credit or insufficient financial resources.
Unfortunately, the move might not be as beneficial for you. Though there’s a chance that co-signing another person’s loan could improve your credit score, that’s not always the case. In fact, there are quite a few risks that come with being a co-signer, and if you’ve been asked to be one yourself, it’s important to consider it from every angle before moving forward.
Co-signers vs. co-borrowers
There are two types of parties that can apply for a loan alongside you: a co-signer and a co-borrower. In both situations, all parties are legally responsible for the debt that’s being taken out. The credit scores and financial details of both parties are also considered in the application.
After that, the two roles diverge. Here are the big-picture details of both scenarios:
- They have no title or ownership in the property (house, car, etc.)
- They’re legally obligated to repay the loan if the primary signer falls behind
- Their income, assets, credit score, and debt-to-income ratio are considered in the loan application. Co-signers are often used to help applicants qualify who wouldn’t otherwise be able to.
- They’re on the title or have some claim to the property.
- They’re typically spouses, family members, or loved ones you plan to live with and split costs with.
- Their income, assets, credit score, and debt-to-income ratio are considered in the loan application. This may make it easier to qualify for larger loan amounts and more favorable terms.
Co-signer rights and responsibilities
If you’re considering co-signing a loan for someone you know, it’s important to know your rights and responsibilities first.
The most important thing to note is your financial responsibility. Though the primary borrower should make the established monthly payments on the loan, that doesn’t mean they always will. If they don’t, it’s your responsibility to pick up the slack.
Unfortunately, this doesn’t give you rights to the property, car, or other security that the loan is paying for. You’re simply a financial guarantor, and if the primary signer fails to repay the debt, then you’re next in line to make it happen. Depending on how late they are, you also may owe penalties, late fees, additional interest, and more.
If the primary signer stops making payments or falls behind, you can also request a co-signer release. This is a form that the primary borrower will need to sign off on, releasing you from the obligations of the loan. The lender also must approve the removal of the co-signer (which it will only do if the primary borrower can demonstrate they have the credit and history to handle the payments).
Can being a co-signer hurt your credit?
When you co-sign a loan, it will go on your credit file just as it will the primary borrower’s. That means it can either help your credit or hurt it. If the primary borrower makes on-time payments consistently and throughout the course of the loan, you might see a small boost. If they’re late or fall behind on payments, then your credit score will drop as a result.
That’s not all, though. If the primary borrower falls way behind and you’re unable to bring the loan current, you could have a foreclosure or default on your hands. That would go on your credit report just as it would theirs, which could impact your credit and financing options for many years to come. Depending on the type of loan, you could even find yourself in a legal battle against the lender. (In some cases, they may even garnish your wages until it’s repaid.)
There’s a lot to think about if you’ve been asked to co-sign on someone’s loan. Obviously, your good credit could help a friend or loved one achieve their financial goals, but is it a good thing for you? Not always.
First, you’ll want to consider the type of loan you’re co-signing for.
Secured loans are riskier for borrowers because there’s collateral on the line — a house, car, or another piece of property. Any added risk for the primary borrower is added risk for the co-signer, too. (For example, a HELOC might seem like an easy way for you to help your child pay off a massive medical debt, but it also puts their house at risk. If they can’t keep up their HELOC payments, as well as their current mortgage loan, where will that leave you?)
You should also consider your financial situation.
Generally, lenders want to see co-signers with high credit scores, a blemish-free credit report, and a long history of consistent, on-time payments. They’ll also want you to have steady employment and verifiable income. Does this apply to your financial scenario? If it does, are you willing to risk your high-credit status to co-sign the loan?
Finally, think about the long-term rewards of being a co-signer.
If you’re doing it to help your child go to college or build up credit early on, then the risk may be worth it in the long run. If you’re simply helping a friend pay off credit card debt or buy a car that’s outside their price range, it’s probably not the best move — for you or for them.
When co-signing is smart:
- Your financial situation is stable, and you want to help out a family member or friend.
- You’re acting as a co-borrower on the loan and will share in the responsibilities of the house, car, or other property equally.
- You know the primary borrower well and are confident they can hold up their end of the bargain.
- You plan to make the payments on the loan yourself (you’re helping your child build credit, attend school, etc.)
When co-signing might not be the right move:
- You don’t know the primary borrower well, you’re not confident in their ability to repay the loan, or you feel they might be untrustworthy.
- You don’t have a permanent relationship with the primary borrower. (They may not be in your life five to 10 years from now).
- Your financial situation is unstable, or your income fluctuates.
- It could cause strain in personal relationships if the primary borrower falls behind.
- You can’t comfortably handle the payments on your own if necessary.
- You may need another loan before the debt is repaid. (Your high DTI could make it difficult).
You should know the primary borrower well before choosing to co-sign a loan with them. How stable are their finances? How responsible are they? How likely is it you’ll still be in contact in a few years? Make sure you only take this financial risk with someone you know and trust.
The bottom line
At the end of the day, it’s important to remember what’s on the line. Though co-signing could improve your credit if the primary borrower stays current on their payments, there are also a number of risks to consider. Not only could co-signing a loan threaten your credit score, but it could also impact your future financial prospects for many years. Make sure you consider the full scope of your liabilities, risks, and rewards before deciding to sign on that dotted line.