Cosigning a car loan or a mortgage for someone is a big decision and one that shouldn’t be taken lightly. When you decide to be a cosigner for someone, you are making yourself legally responsible for taking up the payments if she cannot. While it is extremely generous of you to do so, should she default on the loan, you are going to be on the hook and your credit could take a hit. While you probably really want to help a close family member or friend in need of a cosigner, is cosigning a loan a good idea? Fortunately, there are few alternatives to cosigning a loan that can help the borrower, without exposing you to as much risk.
TL;DR (Too Long; Didn't Read)
If you are not willing or able to cosign for a mortgage, you can explore other methods of financial assistance, such as gifting funds or taking out your own loan in order to secure funds for the mortgage holder.
What Is a Cosigner?
If someone’s credit isn’t so great, or her income alone isn’t enough to qualify for a loan, the lender will usually require a cosigner on the loan. The cosigner agrees to use his income and credit to help secure the loan, but this very generous act is not without its consequences. Acting a guarantor for the loan, the cosigner is also legally agreeing to repay the loan should the borrower default. However, a cosigner is different from a co-borrower, also known as a joint applicant or co-applicant, in that he does not have to make regular payments on the loan.
A co-borrower, on the other hand, is responsible for making payments on the loan right along with the other borrower. Also, as with a cosigner, should one party default on the loan, the other borrower will still be responsible for making timely payments and keeping the loan in good standing. But if you cosign a loan, you’re only liable for stepping up to pay on the loan in the event the borrower can’t. Not paying on a loan in default that you have cosigned for will undoubtedly have a negative impact on your credit score and history.
Implications of Cosigning a Loan
A person who needs a cosigner for a mortgage likely has bad or, at the very least, less-than-stellar credit. This does not make them a bad person, however, the bank or other lending institution has assessed her risk and determined that she may not be able to keep up with timely payments and could possibly default on the loan. If a bank is unwilling to offer financing because of this risk, you need to seriously consider if assuming the risk associated with cosigning a loan is something you really want to do.
Cosigning on a loan can also make it more difficult for you to obtain financing of your own in the future should you want to qualify for a mortgage or, say, a car loan. Because the loan will likely be reported to credit reporting agencies, having someone else's mortgage on your credit report has an effect on your debt-to-income ratio, or DTI. Although you aren't responsible for paying on the loan, and are only cosigning for it, the balance is still perched on your credit report until it's paid off.
When your DTI is too high, this means you have too much debt for the amount of income you make, and you may have a harder time qualifying for other loans. Even if the loan you cosigned for is being paid in a timely manner, the balance is still included in your overall debt, which can make it more difficult for you to qualify to take on more debt later on.
Gifting the Money Yourself
If you really want to help someone who needs a cosigner, you do have a few options you can consider before having to flat-out say “no.”One such alternative to cosigning a mortgage is to lend your friend the money yourself. Depending on the mortgage, you can gift some or all of the money required for the down payment on the property. However, lenders typically have criteria that determine who can make gifts, so check with your loan officer for clarification.
This is a viable option to cosigning on the loan because the more money she is able to put down on the home, the smaller the loan balance will be. The gift of a down payment may be able to help her get into a property that she would have otherwise not qualified for without a cosigner. You do need to be aware, however, that the IRS does impose a gift tax in some situations on certain monetary gifts, and that tax is paid by the person doing the gifting. In 2019, gifts are exempted from tax unless they surpass $11.4 million over the course of the gifter's lifetime, but this figure can change, so check the IRS' website for gift-tax exemption information.
More Alternatives To Cosigning
You can also try to lend your friend or relative some money to help with the purchase of a home, or to pay down debt to help her qualify for the loan on her own. One way to come up with a little financial assistance is to take out a loan yourself or tap into your savings. Although, you are still taking on a responsibility to pay if you take out a loan, you won’t be placing yourself at as much risk as you would were you to cosign for a mortgage outright. To make it more official, you can draw up a loan agreement – with reasonable interest and repayment terms – between you and the person who asked you to cosign.
There are some key pluses to lending the money yourself. If you draw up a contract, it is legally binding. You also may be able to write the bad debt off on your taxes if you aren’t repaid. In addition, your credit won’t be harmed by someone else not paying on a debt you cosigned for. In fact, if you repay the loan in a timely fashion, you will likely see a boost in your credit score.
When you decide to borrow money to lend to someone else, there is a chance you will not be paid back. So, you may want to look at the loan as a form of a gift. If the person who asked you to cosign a mortgage cannot pay you back, then it’s probable that you would have had to step up and assume the mortgage payments on the loan anyway and face a possible hit to your credit report in the process.
Just Say No
There are times when you simply don’t feel comfortable or are unable to help someone by co-signing for a mortgage, and it’s alright to say, “no.” Agreeing to cosign a mortgage could mean years or even decades of someone else’s debt looming over your head and credit report. Should you need to take out a loan or obtain a line of credit for a business venture or other personal need, then you could be denied.
You can be supportive and offer to find alternative lenders, funding sources or government programs that assist buyers with less-than-perfect credit or low-income with qualifying for mortgages. Your friend or relative has to be understanding of the implications that cosigning a mortgage can have on you and your future.
- Nerdwallet: How to Say No to Co-Signing — and Yes to Helping
- SmartAsset: What Are the Rules for Down Payment Gifts?
- AmericanFinancing: Understanding Co-Borrowers vs. Co-Signers when Applying for a Mortgage
- TheMotleyFool:3 Reasons to Say No to Cosigning a Loan
- The Wall STreet Journal: WSJ Tax Guide 2019 – Estate and Gift Taxes