What to know about co-signing a loan

Before you jump in to help someone with a financial commitment, it’s helpful to understand how the decision could impact your credit.

What is a co-signer?

A co-signer is an individual who agrees to repay a loan if the primary borrower fails to make payments. Essentially, this person takes on a financial obligation to ensure the loan is paid in full. Co-signing a loan is not an easy decision. It's a financial responsibility that can have both positive and negative impacts on your credit and financial future.

Risks of co-signing a loan

As a co-signer, you take on risks. Here are some to consider:

• Credit risk. If the primary borrower fails to make payments, it can negatively affect your credit score. Your credit history could be affected by how the loan is repaid, regardless of who's making the payments.
  
• Financial liability. If the primary borrower defaults on the loan, the co-signer is legally responsible for repaying the loan in full, including any late fees or collection costs. And in some states, the lender can sue you for non-payment, in which you will need to pay for all costs including legal fees.
• Reduced lending capacity. Being a co-signer may affect your ability to get your own loan as it adds to your existing debt obligations. This means it will increase your debt-to-income ratio which lenders consider during loan approval.
• Relationship strain. If the borrower cannot make payments, it may affect your relationship with them. You might have to have hard conversations about the fact you will need to begin making payments so your credit history is not affected.

Pros of co-signing a loan

Despite the risks, there can be some benefits to co-signing a loan. Here are two main advantages:

• Helping someone in need. If a family member or a friend has poor or no credit history, co-signing can help them get a loan they might not otherwise qualify for.
• Credit building. If the primary borrower makes all payments on time, it can positively impact both your credit scores, potentially making it easier to get credit in the future.

Factors to consider when co-signing a loan

Here are some things to keep in mind before you cosign a loan:

• Borrower's reliability. How confident are you that the borrower can make regular payments? Do they have a steady source of income? Evaluating their financial stability and responsibility is essential.
  
• Financial capacity. Can you afford to repay the loan if the borrower defaults? Assess your financial situation carefully to determine if you would be able to make payments in the case the borrower cannot.
• Relationship value. Do you have a close relationship with the borrower? Think about potential risks to your relationship if things go wrong.
• Difficulty of removing yourself as a loan co-signer. After you are legally added as a co-signer, it might be difficult to be released from that responsibility. Take the time to review the rules and terms of the contract to understand if this is even an option. In the case it might be, the financial institution will typically look at the payment history and do a credit check of the borrower before this change can be done.
• Car insurance and co-signer on a car loan. Generally, a co-signer on a car loan doesn’t need to be added to a car insurance policy, unless they will be driving the vehicle regularly (like a parent that might be a co-signer on their child’s car loan) or on the vehicle title. The co-signer only has a financial responsibility to the loan, and not to the car (unless they are also part of the car insurance policy as a co-driver).
• Ownership of the property financed by the loan. As a co-signer, you don’t have rights or ownership of that property, only the main borrower does.

Now that you have read some information about what it means to be the co-signer of a loan, you may want to learn about how to monitor your credit from home.