Co-Signing a Loan: Risks and Benefits


Co-signing a loan is a great way to help someone get easy approval if you have a much better credit score than theirs. But there are some risks you must be cautious of.

If your child is new to credit or is rebuilding their finances, you can get them a sweet spot as a co-signer if you have an established credit history. When doing this, put some of the surprising consequences into consideration.


Who is A Co-Signer?

A cosigner is a person who agrees to be legally responsible for the loan consequences of a borrower if they appear to be unfit to make repayment.

Many borrowers want the support of a co-signer to qualify for loans simply because they are unable to qualify for a wide range of reasons. So, you can be of help if you have a strong credit history, to help them improve their odds of being offered the required loan.

The interesting part is that even though you so-signed a loan for a borrower who needed your help, you do not have access to the money. Joint loan loans will give you that access.

Co-signing A Loan

Benefits of Co-signing

When you co-sign a loan for someone you’ll be helping them achieve their financial, educational, personal, and perhaps, family goals. They may also be able to qualify for a credit card and other products they couldn’t have on their own and may get reduced interest rates on the loan offer too.

Someone who is rebuilding their credit or is new to credit can leverage on a co-signer with good credit to build theirs. But then, not all online personal loan providers will co-signers, so check before getting started.


Risks of Co-signing A Loan

The benefits of co-signing a loan seem good and reasonable, but the risks may appear bigger than expected. However, if you have your proper homework done, you should really have no worry. Here are the risks to look out for.

1. Your credit may be badly hit

As a loan co-signer, both the payment history and the actual loan show up on your credit reports and the borrower too. When the borrower misses a payment, your credit score will be negatively affected, and since payment history has the biggest influence on credit scores, any slight slip can wreck your good credit.


2. You are responsible for paying the total loan if the borrower defaults

This appears to be the biggest part of the risks involved in co-signing loans. Aside from the fact that the borrower is leveraging on your credit to acquire a loan, if they fail to make payment, you’ll be the one to pay back the loan including all the collection costs and late fees involved.  

Hence, it is very important that you assess your own finances to be sure that you can sort out the loan in case anything goes wrong.


3. You may be rejected for future credit

In the long run of co-signing, you may be rejected for credit when you actually need it for yourself. A creditor, you must consider the co-signed loan to make an evaluation of total debt levels and you may be declined the opportunity to extend you more credit.


4. The lender could sue you

The lender could get you sued and not the borrower. Some states permit that the lender goes after the co-signer first to recover their money in the case of any default by the borrower before going after the actual borrower.

Before this happens, the debt has already begun giving you a bad hit on your credit as the borrower would have missed several payments. And once the debt has been delayed for up to 180 days, the lender may take legal action against you as the co-signer.

Once you get sued, you’ll have to repay all the loan costs and extra fees – even attorney’s fees.


5. Your relationship with the borrower may experience a down-turn

When your child fails to make timely payments, they are not likely to disclose the full truth to you until things start getting really bad, and ruin trust in their relationship. Couples who are going through a divorce will usually have to face the financial consequence of co-signed mortgage or car.

In such heated situations, one may find it hard to persuade one’s spouse to pay their own part of the loan especially if there is already a separation.


6. You’ll not have it easy getting yourself out as a co-signer

If the situation worsens, you’ll find it difficult to make any real corrections as the process isn’t always straightforward. One way that my work will be to refinance the loan yourself, so long as the actual borrower is now fit to get new loans without a co-signer.

Credit cards and student loans often require a number of timely payments before a reassessment may be considered by the lender on the primary borrower, to know if they can sort the payment alone.


Can you build credit by co-signing a loan?

There are ways you can build credit by co-signing a loan, and some of them are included below:

So long timely repayments are made to the primary borrower’s loan, which would add to your payment history. But then if you already have well-established credit, you are not likely to see any significant effect on your credit, unlike if the borrower refuses to pay.

The credit benefit that mix that may come to you might be small if your credit mix improves. You should consider both installment loans (with level payments) and revolving accounts (like credit cards).


As for the person you co-signed for, they can boost their credit through your well-established credit, and if they make timely repayment on the account, they can build up a good payment history.


How to protect your credit when co-signing a loan

Before co-signing a loan, make inquiries. Ask about your responsibilities, rights, and how you’ll get to know about payment issues if they arise.

A certified financial planner at New York-based Rightirement Wealth Partners, Byrke Sestok says in addition, “ask the primary borrower for access to the loan account so you can track payments.”

“It’s not a trust issue — problems happen,” Sestok says. “If you find out in the first month that someone is having a problem [paying back the loan], you can do something about it.”

To guard yourself for unplanned occurrences, create an arrangement between you as the co-signer and the borrower upfront and in writing that defines each participant’s expectations. With this agreement in place, you should be able to smoothen out imbalances.


Alternatives to co-signing a loan

There are other alternatives to co-signing a loan which the borrower could consider.

i. Provide collateral

A borrower can provide collateral in the form of savings accounts, an investment, or properties such as a car or home for a loan. The borrower will be the one to bear the consequence of any default in the repayment of the loan. If they fail to pay, whatever asset they pledge as collateral will be forgone.

ii. A borrower can apply for a bad credit loan

Borrowers will find online lenders that work specifically for borrowers who have damaged credit. The lenders provide more evaluation options aside from credit scores. However, you may encounter high-interest rates with online lenders.

iii. Borrowers could consider family loan

Family loans can work better instead of having a family member stand in as a co-signer. With a family loan, a borrower doesn’t have to involve a third party. There is no application and approval process with family loans, but a written agreement could be required between parties. This option could help better than falling victim to predatory lenders or putting someone else’s credit at risk.


You might also like
Leave A Reply

Your email address will not be published.