There are many situations where you might be tempted to co-sign for a credit card or loan. Here are a few examples:
- An 18-year-old college student can't get a credit card on his own because he only did odd jobs over the summer and recent law changes require that a student be 21 or have sufficient income from a job to pay for a card. Because the child's low income doesn’t make the cut, his parents agree to co-sign for the card, hoping it will teach him how to develop good spending habits and start building a good credit profile.
- A young woman is in a difficult financial situation: Her car broke down, and she needs to get a new or slightly used car to get to her job. She has to finance part of it and needs a co-signer because her credit isn't good enough. Her grandmother agrees to co-sign for the car loan.
- A man wants to put an addition on his house, but he's self-employed and doesn't have a great credit score, so he asks his fiancé to co-sign for the loan since she has a steady job and a good credit score.
Co-signing for a loan to help your child, relative, or friend sounds like a noble act, right? You’re just being the credit booster. However, everyone should be aware of the ramifications of co-signing a loan for anyone, including your child or best friend.
You Are the Borrower
Being a loan co-signer means you are the borrower in the eyes of the credit bureaus, so this loan will appear on the main borrower’s credit report as well as on yours.The timeliness of the borrower’s monthly payments could also impact your credit score if they aren‘t made each month.
Your Future Loans Can Be Affected
If you are planning to get a new loan in the near future, the co-signed loan may negatively affect your chances of getting a new loan or may increase the interest rate you would have to pay because of your higher debt-to-income ratio.
Co-Signers Pay Back
According to the Federal Trade Commission (FTC), studies have shown that of all loans that have had co-signers and gone into default, 75% end up being paid by the co-signer. In some states, if the debt holder misses a payment, the creditor could come after you (the co-signer) for the money. Creditors and banks ask for a co-signer because the potential borrower — your child, relative, or friend — doesn’t have the credit rating and/or income to support the loan. So yes, you would be helping them with your fall-back guarantee, but you would also be responsible for the debt if anything goes wrong.
You Are Fully Responsible
If your child, relative, or friend defaults on the loan payments, not only would you be responsible for paying back the loan, you would also have to pay any late fees and accrued, unpaid interest. The worst case scenario would be that the unpaid debt goes into collections, the creditor sues you, and the court gives the creditor the ability to put a lien on your house or garnish your wages. Of course, your credit score would take a beating in the process.
Consider Carefully
Co-signing for a loan to help your child establish credit may be a good idea if you make the amount small enough that you can pay it if your child defaults, and if you set the monthly payments low enough that your child can afford them. The purpose of your co-signing in this case is to help your son or daughter establish a good credit history, so take the time to explain the consequences of good and bad borrowing behavior. Building a good report will be very important for your child when he or she is looking for a full-time job or wants to move into an apartment.
According to the FTC, a co-signer may be able to limit the potential liability in advance by having a clause in the loan agreement stating you are only responsible for the principal of the loan and that you must be notified if there is a missed loan payment. State laws vary regarding a co-signer’s legal obligation, so make sure you understand your rights and responsibilities in your state before you sign.
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This is a guest post by Hollis Colquhoun. Hollis has over 20 years of experience in the financial industry, is an Accredited Financial Counselor and co-author of Women Empowering Themselves: A Financial Survival Guide. Contact her at Women Empowering Themselves. More articles by Hollis:
FAQs
Credit history, credit score, income, debts, employment and other financial details are all likely to be considered as part of the loan application when you agree to become a co-signer for someone.
What do lenders look for in a cosigner? ›
Although requirements can vary by lender, a cosigner typically needs to have good to excellent credit (670 and up) to cosign a loan or credit line. Lenders look at a cosigner's credit score and report as well as their income and assets to determine whether they qualify for a loan.
How do I protect myself as a cosigner? ›
Plan ahead to protect your credit
Ask the primary borrower if they can afford the monthly payment. If not, make a plan together. Monitor loan payments. Whether or not you're aware of the status of the loan, missed payments can hurt your credit.
What are cosigner requirements? ›
Common cosigner requirements
An excellent credit score is best, but try to aim for at least good credit or above (so a score of 670 or higher). Steady income: Your cosigner has to make monthly payments on the loan if you can't.
What considerations should you make before co-signing a loan? ›
Before you agree to cosign a loan, ask the main borrower to make a budget and show you how they'll repay the loan. Make sure the monthly loan payments are affordable for both of you. If the borrower loses their job or has a change in finances, can you afford to pay the loan?
Can you get denied for a loan with a cosigner? ›
A borrower with a poor credit history or negative financial situations, such as bankruptcies or repossessions, will have a harder time getting approved for a loan—even with a good co-signer.
What makes a strong cosigner? ›
Creditworthiness: A good cosigner will have a credit history with a good credit score, typically above 670, and with no red flags on their credit check. Steady income: Ensure your cosigner has a stable source of income from a steady job or other investments.
Can I legally remove myself as a cosigner? ›
Fortunately, you can have your name removed, but you will have to take the appropriate steps depending on the cosigned loan type. Basically, you have two options: You can enable the main borrower to assume total control of the debt or you can get rid of the debt entirely.
What happens if I remove myself as a cosigner? ›
When you're released as the cosigner, you're no longer legally liable for repayment. In addition, you don't have to worry about the potential damage to your credit if your son falls behind on payments, and you're less likely to be denied future loans based on the amount of debt owed on the student loan.
When can I remove myself as a cosigner? ›
In general, to qualify for co-signer release, borrowers must prove they have the ability to pay off the loan on their own, in addition to having no late payments for a set period of time, says Kaplan.
Lenders can consider the credit scores of both borrowers when co-signing an auto loan. If you have a lower credit score, having a co-signer with a higher score could work in your favor. In terms of which credit-scoring model is used for approvals, that can vary by lender.
What are the disadvantages of cosigning? ›
Here are the ways co-signing may impact your finances.
- It can increase your debt-to-income ratio. ...
- It can affect your credit scores. ...
- It can leave you responsible for unpaid debt. ...
- It can damage your relationship with the primary borrower.
While each lender has its own credit requirements, most expect a cosigner to have good credit with at least a 670 credit score.
Can I cosign with bad credit but good income? ›
A cosigner typically has an excellent credit history or a higher income than the primary lender (a.k.a, you), which provides an added layer of security for the lender so they can offer you lower interest rates or higher loan amounts.
What documents do you need to cosign a loan? ›
To qualify as a cosigner, you'll need to provide financial documentation with the same information needed when you apply for a loan. This may include: Income verification. You may need to provide income tax returns, pay stubs, W2 forms or other documentation.
How long does a co-signer stay on a mortgage? ›
Normally, a cosigner will have to stay on the mortgage for a minimum of one year. From my experience, normally a cosigner will stay on a mortgage for several years. When the borrower is ready to have the cosigner removed, they contact the lender to then re-qualify without the cosigner.
Whose credit score is used with a co-signer? ›
Lenders can consider the credit scores of both borrowers when co-signing an auto loan. If you have a lower credit score, having a co-signer with a higher score could work in your favor. In terms of which credit-scoring model is used for approvals, that can vary by lender.
What credit score does a cosigner need for a mortgage? ›
What credit score is needed for a co-signer? As a co-signer, you stand in the primary applicant's place during the approval process. You'll need a minimum 580 median score for an FHA or VA loan. For a conventional loan, Rocket Mortgage® requires a qualifying score of 620.
Are you more likely to get approved with a cosigner? ›
Adding a co-borrower or a co-signer can improve your approval odds when applying for a loan and help you secure better terms. Co-signers back the loan but don't have access to the funds, whereas co-borrowers can access the borrowed funds.
