Cosigning on a Loan? What You Should Know First

There are many reasons why people are turned down for credit:

• No established credit, a big factor for young borrowers
• Past financial problems like bankruptcy
• Poor credit history
• Not enough income
• Too much current debt

In some cases, when people do not meet a lender's borrowing requirements, they may qualify for credit if they have a cosigner or a co-applicant. Both a cosigner and a co-applicant are responsible for repaying the debt in full if the primary borrower does not pay. A co-applicant, however, is usually someone who is making a purchase, like a home or car, with the other applicant. A cosigner is simply using his or her good credit to guarantee the repayment of the loan.

A family member or friend may ask you to cosign a loan if they're not creditworthy in the lender's eyes, but before you agree, it's important to understand what your responsibilities are and how cosigning can affect your credit. And consider this-the FTC describes cosigning as taking a risk that a lender won't.

Understanding What it Means to Be a Cosigner

There are many misconceptions about what cosigning a loan means. It's important you know exactly what you're agreeing to before you cosign.

• 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. If the borrower stops making loan payments, creditors can collect the debt from you without trying to get it from the primary borrower first. They can garnish your 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 don't 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.

The Financial Effect of Cosigning a Loan

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.

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 wellbeing too.