Co-signing a Loan The Risks and Benefits

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Co-Signing a Loan Risks and Benefits
Co-signing for a loan could aid the borrower in qualifying, but it could also hurt your credit score and overall financial situation.


Updated on December 16, 2022

Table Of Contents

You might be required to co-sign a loan by your parent, spouse or acquaintance, particularly if your credit score is higher than theirs.
What may seem like good deeds -- helping someone get money for a new home or college tuition could have effects you don't anticipate.
What is co-signers?
A co-signer is someone who adds the name of their credit history and financial details to the primary applicant's loan application, and agrees to be legally accountable in respect of the loan amount as well as any additional charges, should the borrower be unable to pay.
A majority of people need or want co-signers since they are unable to get the loan all by themselves. If you have a strong financial background, co-signing those with a low credit score or a weak credit history can increase the chances of getting a loan or snagging an interest rate that is lower.
Unlike a in which two borrowers have equal access to the loan when they co-sign the loan co-signer is granted no right to the money even though they are responsible for the repayment.
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Dangers of co-signing on a loan
Co-signing on a loan puts you in a vulnerable position. Here are the hazards to take into consideration and the best way to safeguard your finances and your relationship in the event that you decide to sign a co-signing.
1. You are responsible for the total loan amount
This is the biggest risk: Co-signing a loan isn't just about lending your credit score to assist others. It's a pledge to fulfill their debt obligations in the event that they fail to do so, and that includes any collections or late fees.
Before you co-sign, assess your own finances to ensure you have enough funds to pay for the loan repayments in the event that the borrower who is primary will not be able to.
2. Your credit is at risk
When you co-sign a loan in conjunction with a co-signer, both the loan and the payment history will show up on your credit reports and the lender's.
In the short run you'll experience a brief hit to the credit rating, claims Bruce McClary, spokesperson for the National Foundation for Credit Counseling. The lender's rigorous check of your credit prior to accepting the loan can affect your credit score, he claims as will the rise in your overall credit burden.
The most important thing to remember is: Any missed payment by the borrower can negatively affect your score on credit. Because payment history is a factor, a misstep here can wreck your credit score.
3. Credit access may be affected
The long-term risk of co-signing a loan to your loved ones is that you could not be able to get credit in the event that you request it. Potential creditors will take the co-signed loan to determine the total amount of debt and may decide it's too risky to extend you more credit.
McClary recommends that you check your credit report frequently following co-signing in order to keep an eye on your finances.
4. You could be sued by the lender.
In certain states, if the lender is not receiving payments, it could try collecting money from the co-signer, before going after the principal borrower, as per to the Federal Trade Commission.
To reach this point, the borrower would likely have missed several payments, and the debt would already have started to affect your credit. Lenders are likely to consider legal action if they find that the loan is 90 to 180 days past due.
If the worst happens and you are sued for not paying the bill, you're accountable as the co-signer to pay all expenses, including attorney's fees.
5. Your relationship could be damaged
The borrower could begin paying on time, in full, toward the loan or credit card with good intentions. But , the financial and personal circumstances change.
Children who have problems in the payment of a co-signed credit card or car loan might hide the issue to their parent until the issue worsens, ruining trust in the relationship.
Couples who are going through divorce are often faced the financial ramifications of a car that is co-signed or a mortgage, says Urmi Mukherjee, a certified financial counselor at Apprisen, a nonprofit financial counseling company. In those cases, it may be tough to persuade the other spouse to contribute their fair share in the event that the spouse has left the home or sold the car.
6. Removing yourself as a co-signer isn't an easy task.
If problems arise, the removal of yourself as the co-signer is not always an easy process.
Lenders that allow a co-signer to be removed from a loan will require a credit verification of the principal borrower to ensure they can pay the loan independently. The student loans as well as personal loans typically require a minimum amount of timely payments before the lender can reassess the borrower in question to determine if they can make payments on their own.
Benefits of co-signing a loan
The benefits of co-signing a loan for someone is obvious -- you can help the person get access to student loans, a credit card or any other financial product they would not get by themselves or pay less interest with a lower rate.
If someone is brand new to credit or is trying to improve their finances, having a cosigner with a great credit score and an established credit history is a powerful.
There aren't all online personal loan lenders allow co-signers, so it's worth checking before you submit an application.
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Does co-signing the loan build credit?
Being a co-signer can build your credit in the following ways:
When you pay punctually, it will add to your history of payments. But, if you've got a good score and well-established credit, the impact could be minor compared to the danger to your score if the borrower fails to pay.

There's a possibility of a slight benefit if your credit mix improves. It's helpful to have both installment loans (with level payments) and revolving accounts (like credit cards).

The person who you co-signed with can build their credit in these ways:
It can assist them to qualify for credit they otherwise would not get, improving a weak credit file.

Making on-time payments on the account can build an excellent credit history.

How to safeguard your credit score if you co-sign a loan
Before you co-sign, ask whether the lending institution knows what their rights and obligations are and what you'll do when payment issues arise.
Also, ask the primary borrower for access to the loan account so you can keep track of payments, suggests Byrke Sestok, a certified financial planner at New York's Rightirement Wealth Partners.
"It's not an issue of trust, but problems do happen," Sestok says. "If you find out within the first month that someone has a problem paying back the loanor not paying back the loan], you have the option to make a change."
To plan for such occurrences to prepare for such situations, create an agreement between co-signer and borrower upfront and in writing that defines expectations for each person, McClary says. Your personal agreement can to eliminate mismatching expectations, he says.
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Alternatives to co-signing on a loan
If you don't want to sign a co-signing loan you can choose alternatives for the borrowerto choose from:
Consider an individual family loan If the applicant is hoping to get one of their family members co-sign on their behalf, they can choose to do so instead. A family loan does not require the involvement of a third party lender, therefore there's no formal application or approval procedure, however it must be accompanied by an official, signed agreement between the two parties defining the the terms. Family loans could help borrowers obtain lower rates on loans and avoid lenders who are predatory However, they also put the financial security of another person at risk should the borrower be incapable of repaying the loan.

Offer collateral: A borrower could be able to offer big-ticket items like their vehicle or savings account as collateral for the loan. This is called collateral. It comes with a certain risk. If the borrower is unable to make payments on the loan the loan, they'll lose any asset they pledge.

Online lenders that work specifically with applicants who have bad credit. These lenders have looser requirements than banks and will evaluate other factors other than credit score. However, interest rates at online lenders can be high when you have poor credit as they have the average annual percentage rate being higher than 20%.



Author bio Jackie Veling covers personal loans for NerdWallet.







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