If you’ve built a substantial credit history and have a solid credit score, you might find yourself in the position of being asked to co-sign a loan. Here are some important things to consider before making this decision.
Responsibilities of a co-signer
Per the Federal Trade Commission, a co-signer takes legal responsibility to pay the primary signer’s loan if they default on payments. Like it sounds, co-signing a loan is a weighty obligation that you shouldn’t adopt without thoroughly evaluating the advantages and disadvantages of this financial decision.
Benefit of co-signing
The main perk of co-signing is to provide financial help to a loved one, as U.S. News & World Report’s Geoff Williams shares. For example, co-signing a student loan to help your child fund a university education. Or co-signing the loan for their first car, since financial institutions usually require a co-signer if the primary borrower has no or little credit history. A secondary perk is that a positive co-signing experience can bolster the credit scores of both the primary borrower and the co-signer, if payments are consistently made on time, as Mark Dennis with Forbes articulates.
Some drawbacks of co-signing
Two main disadvantages of co-signing are that it can negatively impact both your credit score and your personal relationship with the primary borrower. According to a Creditcards.com survey, 40 percent of co-signers end up paying some or all of the loan or credit card balance when the primary borrower failed to hold up their end of the deal.
Besides losing money, co-signing can also make you vulnerable to a decreased credit score. Whenever the primary borrower either misses a payment or pays it after the deadline, this “strike” goes on your own credit report and can remain there for a few years, as Dennis confirms. This could also impact your ability to secure future loans.
Ways to reduce the risks of being a co-signer
If you do decide to be a co-signer, experts recommend following a few guidelines to help minimize the potential risks. For starters, agree to co-sign only if the primary borrower is a relative, as Jim Angleton, president of Aegis FinServ Corp. shared with Williams. Avoid co-signing for acquaintances and friends, since any negative experience could damage your finances as well as your relationship with that person.
It’s also important to review your budget before agreeing to co-sign. Make sure you have sufficient funds to cover the primary borrower’s loan payments indefinitely, in case they default on their loan due to losing their job or experiencing some other financial crisis.
Request copies of all documents and statements involved with the loan, as Dennis recommends. You might also consider asking for login credentials so both of you stay up to date on loan payments. Additionally, set up email and text alerts with the financial institution, as Williams shares. That way, you both know payment deadlines and posting dates, and are aware of any late payments.
Lastly, get out of the cosigner role as soon as possible. Dennis articulates two ways of doing this. One way is to create a written agreement with the primary borrower that he or she will refinance the loan under their own name at an agreed-upon time in the future, once they’ve built some credit history. Another option is to make sure the loan you’ll co-sign has a co-signer release option. This document legally releases the co-signer from their obligation to back the loan, once the primary borrower meets certain conditions.
While co-signing has its risks, it definitely has some benefits for those willing to pursue this financial route. By following these guidelines, you’ll be well-equipped to evaluate your finances and decide whether or not co-signing is best for you.