Cosigning can help someone who doesn’t have a lot of credit history get a loan, such as a mortgage or a car. It can also boost a borrower’s credit score.
However, the loan will show up on your credit report and can impact your debt-to-income ratio. It’s a big responsibility to accept and can damage your relationship with the borrower if there are problems with payments or defaults.
The Risks
Many people, particularly younger ones with limited income and credit report history, find it difficult to obtain a loan for a vehicle, home or education without a cosigner. When a borrower asks a parent, spouse or other relative to be a cosigner on a loan, it can have significant legal effects for both parties involved. Depending on the terms of the loan, payment delinquencies may be reported to both the main borrower and the cosigner.
This can have a negative impact on a person’s debt-to-income ratio, making it harder for him or her to qualify for other loans. Likewise, lenders are legally allowed to pursue the cosigner for payment before they pursue the primary borrower in the event of missed payments. This can strain even the strongest relationships, especially if the primary borrower experiences financial difficulties or defaults on the loan. Additionally, cosigning a loan can limit your borrowing power as creditors will view you as having too much debt for your income.
The Rewards
A cosigner helps someone get a loan that they otherwise might not qualify for, especially if their credit is too bad or they have no credit at all. A lender will consider the credit of both the cosigner and borrower, as well as their income when approving the loan. The cosigner may also be able to help the primary account holder build their credit history with on-time payments. If it’s a new type of credit, this could boost their score as well as improve their debt-to-income ratio.
Cosigning a loan can also be a great way to give your loved one an opportunity to have their own credit card and help them meet financial goals, such as buying a home or car. However, the risks and rewards should be carefully evaluated on a case-by-case basis. The loan will appear on both the signer’s and cosigner’s credit reports, so if the primary account holder fails to pay on time, it could hurt both parties’ credit scores.
The Long-Term Effects
Regardless of how well you trust the primary borrower, cosigning can impact your own credit score and financial stability. Adding the loan to your credit report impacts your debt-to-income ratio, and lenders may decide you already have too much debt on your plate. Lenders also have the right to try collecting from you before going after the primary borrower, and that can put a strain on your relationship.
On the other hand, if the primary account holder makes all payments on time and maintains an appropriate debt-to-income ratio, it can positively impact your credit scores. It can also help build your credit mix, which accounts for 10% of your FICO scores, and it can show future lenders that you are responsible with debt. However, if the primary account holder misses payments or sends the account to collections, it can damage your credit and destroy the relationship with that friend or family member. It can even cause you to lose the opportunity to secure your own credit in the future.
The Decision
Lenders take into account the credit histories, income, debt and other financial details of both the cosigner and the primary borrower in making underwriting decisions and determining loan terms. As a result, being a cosigner could impact your credit score and/or credit mix, which makes up about 10% of your score.
If the primary borrower does well with their loan and consistently makes on-time payments, your credit scores might get a slight boost from the new positive notation on your report and the addition of the loan to your credit mix. However, if the primary borrower fails to make their payments, you’ll be liable for the full loan amount and any associated late fees and collection costs.
Overall, cosigning a loan can be an effective way to help a loved one build their credit and reach their personal and financial goals. But it’s not a decision to be taken lightly, as your credit and finances can be negatively affected by any issues with the loan.
