What It Really Means to Cosign a Loan
If you wouldn’t be comfortable taking out a given loan for yourself, then you’ll want to think twice about cosigning that loan for someone else.
There you are, sitting on your couch, minding your own business when suddenly you receive a call. It’s from your nephew! He’s heading off to college soon, but it turns out that he needs to take out a private student loan (or three) to cover his educational costs. And since he’s only 18 and has no credit history, nobody will lend to him.
He’s not asking to borrow money from you, he’s just asking if you’ll cosign a loan (or three) to help him go to school. You love your nephew so you say “sure thing!” He promises to send you the loan documents, and you return to sitting on your couch and minding your own beeswax.
Freeze frame. Was this a wise decision you just made? Granted, things might work out okay for you, but the way you went about this was all wrong. Clearly, you don’t really get what it means to cosign for a loan, or else you’d have asked many more questions. Thank goodness you’re reading this blog post. Here’s what you need to know about cosigning a loan …
You’re lending out your financial reputation.
When you cosign a loan for someone, you are using your financial reputation to help them out. If a person needs a cosigner, that means that they either have bad or thin credit. That means that the only loans they can qualify for on their own are likely bad credit loans and no credit check loans like payday loans, cash advances, and title loans.
But instead, they’ve got you, a helpful friend/parent/relative to give them a boost! By cosigning for a loan, you are taking your good credit score and using it to put the lender at ease. Since you have good credit, and you’re taking responsibility for the loan, the lender can rest assured that they’ll be repaid.
Congrats, you have great credit.
Creditworthiness is the most important aspect of being a cosigner. It’s by far the biggest thing that lender cares about. A great credit score (which is generally considered to be anything over 720) means that you have a long history of paying all your bills on time and not taking out more debt than you can handle. That’s music to a lender’s ears.
On the other hand, if you have poor credit, that pretty much means you can’t be someone’s cosigner. It doesn’t matter how much you vouch for your friend’s trustworthiness, that score is going to be the lender’s primary concern. And if you’re not careful when cosigning, your score could end up taking a hit as well.
You are on the hook.
The reason that lenders allow cosigners is because they have only one primary concern: Getting paid back, no matter what. And that’s the whole point of cosigning a loan—to give the lender some assurance that they’ll be paid back, even if the borrower taking out the loan isn’t able to do that.
So when you cosign a loan, you have to understand that you’re ultimately on the hook for that money. If your friend can’t pay it back, the responsibility will fall to you. Before agreeing to cosign, it’s wise to find out why your friend/relative has a poor credit score in the first place. If it’s because they have a history of bad money habits, you’ll probably want to steer clear.
It’ll affect your credit score.
When it comes to your credit history, cosigning for a loan isn’t seen as any different than taking out a loan yourself. After all, your name is on the loan agreement. So this means that the loan will be recorded on your credit reports, and thus it will affect your credit score.
Here’s the not-so-great news: Cosigning an installment loan could very well hurt your credit, and it’s far more likely to hurt it than it is to help it. One of the main factors in your credit score is the amount of debt (especially consumer debt) that you owe. It makes up 30 percent of your total score. Adding a bunch of money to that total might cause your score to drop.
It can really, really hurt your credit.
While cosigning for a personal loan (or any other kind of loan) might cause your score to drop initially, that shouldn’t be so much the cause for your concern. What should worry you is what happens if the borrower starts falling behind in their payments or, even worse, stops paying the loan back altogether.
If this happens, and their late or missed payments start being reported to the credit bureaus, you can kiss your great credit score goodbye. And that doesn’t even account for the fact that you’ll probably have to step in and start making payments for them (including any late fees they’ve accumulated). Basically, this is the worst case scenario.
The best cosigner is a cautious cosigner.
The number one thing to keep in mind if someone asks you to cosign is that this is a big financial decision. It’s not something you should enter into lightly, or without asking your friend/relative a lot of questions about their finances, their money habits, and why they need the loan in the first place.
The best case scenario for cosigning a loan is that all the payments get made and you go on your merry way. The worst case scenario is that you end up with damaged credit and on the hook for (in all likelihood) years of loan payments for money you never even got to use—not to mention the bad feelings this will cause between you and your friend or family member.
If you don’t feel comfortable cosigning a loan, then don’t. And if you do, make sure that the expectations between you and the borrower are crystal clear. That way, you can reduce the risk of ruining an important relationship over a loan (or three).
To learn more about financial best practices, check out these related posts from OppLoans:
- From Budget to Baller: 6 Tips to Grow Your Money
- The (Comprehensive) Couple’s Guide To Budgeting
- Emergencies and Divorce: How to Plan For Worst-Case Scenarios
- 8 Ways To Save Money Today, Tomorrow and Every Day After
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