In order to get approved for a loan, borrowers usually must meet credit history and minimum income requirements. However, borrowers who do not meet these requirements are not completely out of luck, as long as they can obtain a cosigner – someone who signs the loan document and agrees to pay the loan if the borrower can’t.
Becoming a cosigner comes with risks and responsibilities, so it’s important you fully understand what you may be taking on before you cosign. Here’s an overview of what it means to cosign, what you should keep in mind before cosigning, and how you can make sure the borrower is staying on track.
What it means to cosign
When you cosign for a borrower, you put your own credit on the line to be held liable if the borrower defaults on the loan. Despite being liable for the loan, cosigners receive no benefit of the loan proceeds. For example, despite cosigning for an auto loan, a cosigner does not have a claim to the vehicle. This is what differentiates cosigners and coborrowers.
Good candidates for cosigners are individuals with good credit history and income to support the loan. While cosigners are often family members, they do not need to be related to the borrower. A cosigner can be anyone who meets the age, credit, income and other requirements for borrowing.
What you should keep in mind before cosigning
Beyond the liability of paying the loan if the borrower can’t, cosigners should keep in mind that even if the borrower is making regular payments, the loan will still impact the cosigner’s debt-to-income ratio. Debt-to-income ratio compares your income to your total debt, which lenders take into consideration when you apply for credit. If you are planning to apply for credit of your own – for a mortgage, car, or other loan – be aware that cosigning will increase your debt-to-income ratio and reduce your borrowing ability.
How to monitor and keep the borrower on track
As a cosigner, it’s in your best interest the borrower maintains steady payments so you are not held liable. To help monitor and keep the borrower on track, take advantage of the access you have to payment history and communication from the lender. Lenders do not withhold information regarding a loan for which you cosigned, so if you have questions, you can call to inquire about the progress of the loan.
Request duplicates of any communication coming from the lender, including payment confirmation and late payment notices. Check in with the borrower periodically to ensure they are not experiencing financial hardship and are confident in their ability to continue paying off the loan. If they are having issues making payments, it’s best you know as soon as possible before it results in penalties and damage to your credit.
Be prepared to pay the loan
While you lead with the assumption the borrower will eventually pay off the loan and you will be released of liability, it’s possible you may be held responsible for payments. Before you cosign, be sure you can financially handle the responsibility and keep funds ready in case you must begin paying off the loan.
Cosigning has many benefits, including allowing a borrower to build credit and obtain financing to purchase reliable transportation, attend school, and more. However, before you make the commitment, it’s important you know the risks and are prepared to take responsibility for the loan.