Sometimes a lender needs a little extra security before approving a loan. To strengthen someone else's credit application, you can either co-sign or guarantee. In both cases, the lender will still use your own income and debt as a deciding factor in approval. The difference is when it comes to your overall responsibility and liability for the repayment.
What Is a Co-signer?
A co-signer is equally as liable for a loan as a primary borrower. An individual co-signs a loan when the primary borrower is not financially strong enough to qualify for a loan on his own. The lender reviews both the signer and co-signer’s financial statements and credit reports to calculate the debt-to-income ratio. The idea is that the added income of the co-signer will strengthen the debt-to-income ratio so the primary borrower qualifies for the loan.
Responsibilities of a Guarantor
A guarantor is a secondary form of repayment. The guarantor only becomes liable for the loan in the event the primary borrower can’t repay it. This is common in business loans where the primary borrower is a business entity and the owner guarantees the loan. Again, the lender calculates the debt ratio on the business and guarantor combined to determine if it qualifies. If the business goes under or suffers losses to the point where it can’t repay the debt, the lender has the comfort level of knowing the individual can take over the payments.
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A co-signer is beneficial in that the extra income allows a borrower to get a loan for which he otherwise wouldn’t qualify. This can allow the borrower the opportunity to purchase a home, buy a car or consolidate debt. Having a guarantor on the loan provides the exact same benefit. In the case of a business, a guarantor can help get a loan that will start or expand the company or increase its working capital position.
The risks are where a co-signer differs from a guarantor. If a co-signed loan goes bad, the lender has the right to pursue both signer and co-signer immediately. The co-signer may not have any interest in the collateral or the overall purpose of the loan, but his income and assets are at risk if the bank takes legal action.
A guarantor, on the other hand, only becomes liable when the lender has exhausted all means of collection against the primary borrower. Also, once you’ve signed the documents, you’re locked in to that obligation, be it primary or secondary. A guarantor or a co-signer can only be released from a loan if the lender reviews the financial strength of the borrower and determines that he can make the payments on his own going forward.