Cosigning a Loan Explained

A cosigner is a person who agrees to be financially responsible for a debt along with a borrower. Cosigning a loan can help a new borrower get the cash he or she needs to go to college or buy a car, but it has its risks.

Cosigning a Loan Offers Many Benefits

cosigning a loanHaving a high credit score has numerous benefits, ranging from being eligible for many types of loans to enjoying lower interest rate. Your friends and family may also notice your solid credit, and they might want you to cosign a loan.

Cosigning is steadily becoming a common practice as of late, as many people see it as an opportunity to help a friend. That said, there are some risks to take into consideration before deciding to sign your name on that loan.

What Is a Cosigner?

A cosigner is a person who officially shares the responsibility of paying a debt with a borrower. Generally, a cosigner is someone who has a good credit score and can significantly improve the borrower’s chances of the lender approving him or her.

People who don’t have a lengthy credit history, such as students or recent high school graduates, and would have difficulty getting credit for the first time would benefit from a cosigner.

Reasons to Cosign for a Loan

  1. It helps an applicant obtain financing.
  2. It helps an applicant build credit.

People trying to apply for a loan with poor or limited credit history often face the grim reality of numerous loan rejections. However, lenders will often reconsider a loan application if there is a reliable cosigner with the applicant. This can make important life steps like purchasing a new vehicle or attending college possible.

When you cosign a loan, you have an active share in helping a person build a better credit score, thus opening doors for future lending options.

Risks Associated with Cosigning a Loan

The first risk is that it increases your debt-to-income ratio, which is the percentage of your income that goes toward paying debts. As a cosigner, you are just as financially responsible for the debt as the borrower after you sign the documents.

Another risk is that you can’t remove yourself as the cosigner without the lender’s permission or the borrower refinancing the loan into his or her own name.

And likely the biggest risk of being a cosigner is to your credit score. If the borrower defaults on the debt, your credit will receive the same negative marks as the borrowers.

When Does Cosigning Make Sense?

Cosigning is ultimately a personal choice, and your reasons for cosigning may outweigh the risks discussed above. For instance, cosigning a loan for your child to help him or her get a student loan is a worthy cause.

Cosigning might be a good idea if you don’t plan on financing anything major in the near future. If you plan to buy a home or car in near future, you may have troubles getting approved for a loan due to you cosigning on someone else’s loan.

Only cosign for a loan after you’ve fully explored your financial future and are certain this will not negatively impact you in the future. Also, you need to make sure you can afford to pay the loan if the borrower defaults.

 Obligations of a Cosigner

  1. You are financially responsible for the debt.
  2. You may have to pay late fees or collection costs.
  3. The creditor might attempt to collect the debt first from you without trying to collect from the borrower.

Additional cosigner laws may vary by state, so confirm these before cosigning.

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