Cosigning on a Loan? What You Should Know First

When people do not meet a lender's borrowing requirements, they may qualify for credit if they have a cosigner or a co-applicant. A family member or friend may ask you to cosign to help improve their odds of securing the loan. But before you agree, it's important to understand what your responsibilities are and how cosigning a loan can affect your credit.

What does being a cosigner on a loan mean?

It's important you know exactly what you're agreeing to before you cosign. Here are some misconceptions about what happens when you cosign a loan.

• Cosigning is a character reference. Not true. As a cosigner, you guarantee repayment of the loan. If the borrower does not make the required payments, you must make them. You will also be responsible for paying any interest or fees, including court costs and attorney's fees.

• The lender will pursue the borrower for repayment first. Not true. Cosigners are 100% liable for the loan if the borrower fails to make payments. So, if the borrower stops making loan payments, creditors can collect the debt from you. They can garnish wages or sue you to get repayment of the debt.

• If the borrower declares bankruptcy, the debt is forgiven. Not true. Even if the bankruptcy court discharges the debt for the borrower, you are still responsible for paying the full amount of the debt plus any interest and fees unless you also declare bankruptcy.

• If the borrower stops making payments on the loan, the lender has to notify you immediately. Not true. Many lenders may not alert the cosigner until the loan is in default, which can significantly increase the amount you owe through interest and fees and damage your credit report.¹

Does a cosigner have to show proof of income?

Yes. A cosigner may be required to provide some, if not all, of the same proof-of-income documents as the primary borrower.

How is a cosigner’s credit affected?

Even if the borrower you cosign for makes all his or her payments on time and in full, cosigning a loan does affect your credit. The total amount of the loan is considered as your debt and factored into your debt-to-earnings ratio (how much you owe compared to how much you make) when you apply for credit on your own. That means that cosigning on a loan can lower your credit score and limit the amount you can borrow.

Plus, if the borrower does not repay the loan and you are not notified right away, the missed payments are recorded on your credit report as well and can hurt your creditworthiness.

Before you cosign on a loan, think carefully about the risks and what the loan can do to your good credit. It's not just about helping someone out, it's about your own financial well-being too.

*This article has been updated from its original posting on January 1, 2014.