If someone asks you to co-sign a loan, it is typically because they do not possess the requisite credentials needed to qualify for a loan on their own. Your friend or family member might have another shot at getting their application approved if you are willing to co-sign the loan. As a co-signer, you will be contractually obligated to pay off the debt if and when the primary account holder defaults. Co-signers serve an important purpose, helping those with little or negative credit history overcome those limitations and qualify for loans. If all goes well, you may help that person cultivate positive credit history that will allow them to later qualify for a solo loan. However, if the arrangement were to sour — as it unfortunately does all too often — it could have a disastrous impact on your own credit. Before you dive into co-signing a loan, here’s what you need to know.
How It Works
A co-signer is just as critical to the loan as the actual borrower — so that means you will have to show up for the actual signing in person. If you are taking this step, it’s best to treat the situation as if you are applying for the loan yourself. Just as you would with your own applications for loans or credit, you need to evaluate your financial situation and whether you can afford the risk. Simply put, if you could not easily cover the payments if the primary account holder defaulted, co-signing would be the wrong choice.
What It Means for Your Credit Score
Even though you may not submit a single payment as a co-signer on a loan, all of the loan payments will be reported to the credit bureaus as if you had made them yourself. That means that if the primary borrower stops paying, all of the missed payments will show up on your credit report, too. Late and missed payments are the quickest ways to sink a credit score — even if yours was rock-solid when you initially agreed to co-sign the loan. Your score could plummet even more dramatically if the borrower defaults on the loan and it winds up in collections or litigation.
If you decide to proceed with co-signing a loan despite the risks, make sure you let the primary borrower know that you will be keeping tabs on their payments. Find out what day the payment is due and give them a heads-up a few days before. It’s in your best interest to ensure the payments are made on time every month — even if it means you have to nag the primary borrower.
Loan Approvals Will Get Trickier
Adding another loan to your financial load — even if you aren’t technically making any payments on it — will make it tougher for you to qualify for loans or credit. Creditors or loan officers will observe that your amount of debt has risen but your income, most likely, has not.
Contracts Are Rock Solid
You may think that you can easily request a release from the loan if circumstances change. Unfortunately, loan terms and conditions are ironclad for that very reason — so that if the primary borrower shirks their commitments, the loan officer can seek you out for payment. You’ll be on the hook for as long as the debt is unpaid. Don’t rely on a verbal agreement with the primary borrower. You may be better off asking the loan officer directly if the contract includes a provision for release.
Unfortunately, the doom-and-gloom scenario may very well play out in reality. If a loan officer is hesitant to take a risk on a borrower, they have a very good reason. Your friend or family member may likely default, leaving you fully responsible for repaying the debt — plus any interest and collection costs that have accrued when the original account holder’s payments lapsed. Even though that is exactly why you co-signed in the first place, it can still be hugely unsettling to begin receiving collection notices and even warnings of legal judgments. Beyond the financial repercussions, your relationship with the borrower may not recover.
Although co-signing a loan is a generous gesture, you may decide it is ultimately not worth the risk. Consider alternatives, such as offering financial assistance in another way — one that doesn’t put your credit score on the line.
We offer a wealth of educational content to help you navigate credit and financial concerns here at Ovation Credit, but that’s not all we do. Head here for a free consultation to find out more about how we can give your credit reports an instant boost.