Before you Cosign for Somebody
Understand and Manage the Risks
When you cosign a loan, you promise to pay off somebody else's loan if that borrower stops making payments for any reason. This is a generous act, as it can help a friend or family member get approved for a loan that they otherwise wouldn’t get. But it’s risky to guarantee a loan for somebody else – don’t cosign unless the situation is right.
What does it Mean to Cosign?
A cosigner is somebody who helps a borrower get approved. Some borrowers are unable to get approved on their own: they don’t have enough income to cover the loan payments, or their credit score may be too low (whether that’s because of problems in the past, or simply a lack of borrowing history).
When you cosign, you agree to take on the loan with the borrower: you become 100% responsible for the debt. If the borrower is unable (or unwilling) to make payments, the lender will expect you to make payments. That includes any and all monthly payments due until the debt is completely paid off, plus any late or penalty fees. You’re expected to get the payments in on-time.
To cosign, you'll actually sign the loan agreement with the borrower or agree to terms online.
Risks of Cosigning
It’s great to help somebody get a loan, but it’s essential to understand the risks before doing so. There’s a reason the lender wants a cosigner: the lender isn’t confident that the primary borrower can repay in full and on-time. If a professional lender isn’t confident in the borrower, you’d better have a good reason for taking these risks.
Damage to your credit: if the loan does not get repaid as agreed, your credit will suffer along with the primary borrower’s credit. Late and missed payments will show up on your credit reports, and your credit scores will fall. This makes it harder for you to get loans, and there may be other consequences (like higher insurance rates).
Got money? You’ve agreed to cover the loan payments, so lenders will expect you to come up with the required payments – plus you’ll be paying late fees on top of those monthly payments. It doesn’t matter if the borrower has more money than you do – the lender is going to collect wherever possible, and you agree to put yourself into the mix when you cosign. It also doesn’t matter why the borrower isn’t paying: they might lose a job, pass away, become disabled, or simply disappear. You’ll get calls and letters from lenders (and eventually debt collectors) and you may even have legal judgments against you.
Legal judgments: if you don’t make payments, lenders may bring legal action against you. These attempts to collect will also appear on your credit reports and do further damage. What’s more, lenders may be able to garnish your wages and take assets from your bank account if you don’t willingly make payments. This is not a risk to be taken lightly.
Reduced ability to borrow: when you cosign a loan, other lenders see that you’ve agreed to guarantee somebody’s loan. As a result, they assume that you’ll be the one making payments. This reduces the amount of your monthly income that is available to make payments on new loans. Even though you’re not borrowing – and even if you never have to make a single payment on the loans you cosign for – it’s harder for you to qualify for the loans you need. This can prevent you from buying a home or automobile.
No easy out: once you’ve cosigned, you’ve entered into a long-term relationship. Lenders are reluctant to let you off of the loan – why would they, when they have two (or more) people to collect from instead of just one? It is possible to remove yourself from the loan in some cases, but this doesn’t always work the way you’d hope.
All of the Risk, None of the Benefits
When you cosign, you become responsible for the debt – that’s it. You don’t own whatever is being bought, and you don’t have a right to the property just because you’ve cosigned. If a borrower stops making payments, there might (in the right situation) be convoluted legal procedures you can follow to regain some of what you’ve lost, but don’t get your hopes up – and the time and energy you spend will be gone for good. If you’re not into taking risk, avoid cosigning.
When it Makes Sense to Cosign for Somebody Else (Maybe)
It’s hard to claim that cosigning never makes sense. It’s risky, but you just need to evaluate the risks and decide what to do.
You can afford the risk: if you can afford to take the risk and you just want to do it, then it might make sense to cosign. This might be the case if you have plenty of extra cash flow and substantial assets available to pay off a loan if your borrower defaults. You’d also want to make sure you’re good for any potential borrowing that might be in your future – you need enough income and assets to qualify. Remember that you might be able to afford the risk now, but you need to be able to absorb losses at an unknown time in the future as well.
You’re in it together: if you’re truly borrowing with somebody, it could make more sense to cosign. For example, you might be buying a car that will be part of your household, and your partner needs a little boost to get approved. That said, it might be better to be a co-owner of the car and apply for the loan jointly.
You want to help (and there are no other options): in some cases, people just want to help somebody else, come what may. Again, you’re taking substantial risks when you cosign, but you may be willing to take those risks. Sometimes things work out fine – but you need to be prepared for things to go badly.
Alternatives to Cosigning
Before you cosign, evaluate the alternatives. Get creative and figure out what will accomplish what everybody needs – while keeping everybody safe. A few ideas to get you started are below.
Help with down payment: instead of cosigning so that your borrower can afford the loan, help out with a down payment instead. A larger down payment could result in lower required monthly payments – making it easier for the borrower to qualify with limited income. Obviously you need to have substantial cash on hand, and you need to communicate about how to handle that down payment (is it a gift, or do you need to set up a private loan agreement?).
Lend: speaking of private loans, you can lend the money yourself if there’s a high risk of default (assuming you can afford to lose the money). Make sure you communicate clearly about expectations and get the agreement in writing. A private loan – where you are the bank – is another great way to help somebody. However, these loans can make things awkward and ruin relationships, and it might be harder for the borrower to build credit with these loans.
If you Cosign for Somebody
If you decide that cosigning makes sense for you, manage the risks to protect yourself and your relationship. Don't be surprised if you have to pay: the Federal Trade Commission (FTC) once reported that as many as 75% of cosigners are asked to make a payment for somebody else.
Communicate: communication is harmony. Stay in close contact with the primary borrower, and encourage communication early and often.
Get info: make sure you’ll have access to the loan information and payment history. Request that the lender inform you of any late payments – a letter is great, but sign up for text or email alerts if possible.
Keep current: if you find that payments are getting missed, try to keep the loan current to avoid damage to your credit (by making the payments yourself). This isn’t what you want to do, but it’s what you’ve agreed to. Of course, you’ll also want to find out what’s going on with the borrower and get them back on track.
Manage the risk: when the goal is simply to help somebody build credit, manage your risk by keeping the loan small and short-term. If it’s a loan you can easily pay off, you’ve got less to worry about. And a loan that’s due within a year or so means you can spend less time and energy keeping track of the loan.
Get released: some loans allow a cosigner to be released after certain conditions are met (for example, if the borrower makes on-time payments for a certain amount of time). Take advantage of this opportunity as soon as possible. Even if you expect the borrower to continue paying, it’s worth getting off the loan so that you can free up your income, and you never know what surprises will come in life.