Cosigners are individuals who essentially agree to vouch for the financial reliability of another party. By doing this, the cosigner assumes a type of "backup" responsibility. If the person they’re cosigning for defaults on a loan, the cosigner then becomes liable for repaying the debt. Taking on the role of cosigner means using your own credit and income history as part of the loan application process.
Why Be A Co-signer?
Cosigning a loan for someone, usually a family member or close friend, allows you to help someone achieve a financial goal without actually loaning them cash. You might cosign a loan for an adult child to help them establish a credit record, or for a friend who is trying to overcome a hardship and get back on firm financial footing. Cosigning a loan for another person can go a long way toward helping them bounce back from re-possession, bankruptcy or late payments that negatively impact credit.
Potential Pitfalls of Cosigning
Keep in mind, cosigning is not without risks. You'll have to verify your own income and credit history for the lender. Cosigning a loan can also throw off your own debt-to-income ratio if you decide to apply for another form of credit on your own. It can also strain relationships if the person you’re cosigning for defaults. You will be on the hook for the payments, which could be a financial hardship as well.
Credit and Income Issues
Cosigners have to go through the same type of loan approval process as the primary person seeking the funding. This means providing copies of pay stubs and possibly tax returns, and agreeing to have your credit report run. Just as if you were applying for your own loan, your credit score matters to lenders, even in a cosigning capacity. The interest rate and fees the primary borrower will have to pay will be a reflection of your credit score, though sometimes lenders will take an average of your score and the primary borrower's score in setting rates.
Things to Consider
Before you agree to be a co-signer, it's a good idea to ask yourself a series of important questions. Do you trust the person I'm cosigning for will be financially able to repay the loan without my assistance? If the other party defaults, can you manage to make the payments without putting yourself in financial jeopardy?Do you want to make a major purchase, like a house or car, in the near future?
Being a co-signer on someone else's loan could impact your ability to secure financing for yourself. Will your relationship with the person you are cosigning for be fractured if they become unable or unwilling to repay the loan per agreed upon terms?
Have an honest talk with the person you are cosigning for before making the commitment, and make sure you understand your rights and responsibilities in this role.