When someone doesn't have good enough credit to get a loan, a co-signer can help. The co-signer uses her credit to help qualify for the loan and agrees to pay the loan if the original borrower can't. This arrangement offers advantages to both people who sign, but it also has drawbacks. If you need a co-signer, understand the implications of what you are asking for. If you will be the co-signer, understand your risks.
Higher Risk than Banks Accept
When a bank or other lending institution requires a co-signer, the reason is that the loan is too risky. The person asking for the loan doesn't have the credit rating and track record to earn the lender's confidence that the loan will be paid back. If you co-sign such a loan, you agree to take on more risk than the lender is comfortable with, which can put you at a disadvantage. The borrower is risking the relationship with you if he can't pay the loan back. If the risk is higher than commercial lenders tolerate, and should give you pause.
Depending on Someone Else
A borrower and a co-signer have to depend on each other. The co-signer is counting on the borrower to repay the loan, and the borrower is at the mercy of the co-signer's credit rating to determine what amount she can borrow. This can be a disadvantage, especially if one of the parties does not live up to expectations. For example, a co-signer may become unsatisfied with the relationship if the borrower defaults, and the borrower may be disappointed with the amount the co-signer qualifies for.
Impact on Credit Rating
Having a creditworthy co-signer makes qualifying for a loan much easier, but it has an additional advantage for the borrower. If the borrower can successfully pay back the loan, he will have established a positive relationship with the lender, created a track record and improved his credit rating. The co-signer will also see an improved credit rating, because the paid-off loan will count toward her positive borrowing record.
Using the Money Wisely
One great advantage of using a co-signer is the ability to get the cash. If you use the cash wisely to fund your education, buy a vehicle or consolidate loans, the risk may be worth the reward. However, this type of loan is not as attractive to a co-signer if the purpose is frivolous or does not produce some kind of reward. Generally, a co-signer is either a family member or a friend, so part of the motivation to co-sign is to see a loved one succeed. This advantage is not tangible, but it can be a strong reason to co-sign a loan or to ask someone to co-sign.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.