Your phone rings. A friend or family member says they’re applying for a personal loan and need a cosigner to get approved. If they ask you, what would you say?
As with any financial decision, it’s important to recognize the risks and responsibilities of cosigning a loan. Here’s some information to help you make the best choice:
How does cosigning work?
A cosigner signs a loan application to help improve the chances of someone else getting approved for the loan. Cosigners are generally needed when the person applying for a loan fails to meet a lender's borrowing requirements. This can happen due to a low credit score, insufficient income or other factors. In order to improve the odds of getting approved, the cosigner must have a higher credit score or income than the applicant.
Some lenders, like OneMain Financial, do not allow cosigners. However, they will accept collateral such as a car or motorcycle to secure the loan, or permit a co-borrower on the loan.
What’s the difference between a cosigner and co-borrower?
You may have heard the terms cosigner and co-borrower before. Although there are small differences between the two, and they could be described differently in a legal contract, they share one very important detail: both are 100% legally liable to pay back a loan if the primary borrower defaults.
To be clear, it may be typical for lender to seek repayment from the primary borrower first. Some cosigned loans are structured this way. However, the lender is still within their legal right to seek repayment from either party. So even if your name is #2 on the contract, you are equally responsible for making sure that loan gets paid back in full and on time.
Pros and cons to consider
These can vary depending on your situation, but all are worth considering:
You can help the person get approved — If someone close to you has fallen on hard times or is rebuilding their finances, you could have an opportunity to help them succeed.
You can help the person get a lower interest rate — Depending on your credit profile, you could help the person get a lower interest rate. Other factors that influence interest rates may include the primary borrower’s credit score, the term of the loan and whether collateral is being used.
You can diversify your types of credit — Having different types of credit obligations may be one of the less significant factors in your credit score, but if you don’t have any installment loans on your credit report, adding a new type of credit could increase your credit score.
You’re responsible for repayment – You are on the hook for repaying the loan, along with the borrower. So, if they miss any payments, you could face collection action from the lender, unless you make the payments yourself.
Missed payments can affect your credit score — Since your credit profile is attached to the personal loan, any missed payment can lower your score.
It might be harder to get a new loan for yourself — Adding new debt could negatively impact your credit profile and make it harder to be approved for a loan yourself.
Your relationship could be strained — If there are any disagreements about the loan, it could cause tension between you, the primary borrower and other friends and family.
Think it through
Helping someone you care about can be a special opportunity. However, before you decide, make sure you’re 100% comfortable with signing, or not signing , the dotted line.