What You Need to Know About Co-Signing a Loan
Sometimes when a consumer is having a hard time getting a loan, he or she will ask someone else to co-sign. This can make it easier to qualify for that loan. Co-signing a loan is a big decision for all parties involved. It can be a complicated one too. Let’s explore co-signing in-depth.
What is Co-Signing?
Co-signing is a simple matter. Let’s see an example:
Susan has low credit or no credit, and cannot qualify for a loan on her own. Joe is a friend or family member with higher credit. Joe co-signs the loan with Susan, taking equal responsibility for it. In this situation, Susan is the primary borrower and Joe is the co-signer.
The loan is approved because Joe’s higher credit reassures the lender. If Susan defaults, Joe will pay off the loan and interest. It is important to understand that both Susan and Joe have taken on the full burden of the debt. Both parties will be held responsible if the loan is not paid off in full and on time.
Situations Where Co-Signing Might Be Logical
Co-signing might make sense if:
- The applicant needs help building credit. Say for example your son or daughter is fresh out of college and needs help building credit. Co-signing on loan with him or her may save your child a lot of time, effort and struggle.
- The applicant needs a hand qualifying. Perhaps someone has an urgent need for a loan, but insufficient credit. For example, the applicant may have a shot at starting a business, but only if he or she receives a business loan quickly. Without your help, the applicant is not going to qualify. With it, he or she will. The loan could be life-changing.
- You and the applicant are borrowing toward the same purpose. For example, co-signing a loan could be the co-signer’s indirect way of investing in the primary borrower’s new business.
Pros and Cons of Co-Signing a Loan (Different Perspectives)
Co-signing is risky, and has potential benefits and drawbacks for all parties involved.
Pros and Cons of Co-Signing a Loan from Lender’s Perspective:
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- The lender may be able to approve a loan which would be declined otherwise. This is an opportunity to charge interest and fees.
- The lender has two parties who can answer for the loan. If one party becomes uncommunicative or stops paying, the other may pick up the slack.
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- Co-signing is inherently risky. If there is a falling out between the two parties, or if the finances of one become a strain on the other, they could default.
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Pros and Cons of Co-Signing a Loan For the Co-signer:
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Cons |
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- Co-signing is a great way to support someone. This is the main reason to co-sign on loan. The co-signer has the chance to make life easier for a family member, friend, or other trusted associate. In some cases, doing so may even change that person’s life.
- There may be indirect financial benefits. Again, consider the situation where you are co-signing on a business loan for someone. You might offer this in return for some kind of perk or payment later down the line once the business is profitable.
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- Debt-to-income ratio goes up. The assumption is going to be that the co-signer’s money is tied up in the loan, even if the primary borrower is making all the payments. This may make it harder to qualify for other financing.
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- Credit could take a hit. If the primary borrower is late on a payment, the credit scores of both parties can drop.
- If the primary borrower defaults, the co-signer is responsible. That may mean paying off the entire loan, plus the interest and fees.
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Pros and Cons of Co-signing a Loan For the Primary Borrower:
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Cons |
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- The primary borrower may qualify for a loan. This benefit is simple and straightforward. With a co-signer, it is possible to qualify for a loan for which one would be otherwise ineligible.
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- The terms and interest rate on loan may be more favorable. It may also be possible to enjoy better terms and a lower interest rate on loan. This can save money and hassles over time.
- There is an added safety net. Obviously, it is comforting for the primary borrower to know that someone financially less vulnerable is standing by to make payments if something goes wrong.
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- The relationship may be strained. This can be a drawback for both parties, who may end up regretting their decision to co-sign.
- In a few cases, the loan may not be appropriate in the first place. In those situations, the borrower is learning a bad habit of leaning on others unnecessarily.
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How to Find a Co-signer
Need to find a co-signer to help you qualify for a loan? The best bet is almost always a family member or friend. In some cases, a roommate might suffice, or a close associate.
Some companies will co-sign for you for a fee and others that will connect you with a co-signer (again for a fee). Many of these services have complaints, so exercise caution if you fall back on them.
How to Decide Whether to Co-sign on a Loan
Are you the one who is thinking about co-signing? Before you do, ask yourself the following:
- Is the primary borrower likely to be able to repay the loan?
- If the primary borrower defaults, can you afford to pay off the loan?
- Should you be forced to pay the loan off, how big a strain will it put on your relationship?
- In general, do you feel comfortable sharing a financial responsibility with the primary borrower?
If you truly can afford to co-sign, and you are prepared for the consequences if things go south, it may be a situation where co-signing is appropriate.
If the borrower is likely to default, however, or the financial or emotional burden seems potentially too great, consider avoiding the arrangement.
What Can You Do to Help Without Co-signing?
Even if you are unable to co-sign, that does not mean that you cannot help out. Here are a few ideas:
- Lend the money directly. Sometimes it makes more sense simply to lend the borrower some or all of the money yourself. You can even charge interest. At least that way you might actually profit from the situation. And if you lose, you lose less.
- Donate money. If you have the financial means to cover the cost with ease, consider simply donating the money instead. You will have done a good deed, and removed all the financial complexities from the situation.
- Do some networking. The third idea is to reach out through your own network of family, friends, and associates. Maybe you do not feel you can afford to co-sign, but someone else you know may be able to help out.
Conclusion
Co-signing on loan is a risky proposition. There are many situations where it does make sense, but before jumping in, it is important for both parties to evaluate whether it will be worth it. Think through all the ramifications with care before proceeding.
