Has someone you know asked if you would cosign their loan? You may want to help, but do you know how cosigning works? Before you agree to become a cosigner, it’s important to understand what your responsibilities are in this role. It’s equally important to understand the risks involved. These FAQs cover crucial information that you should know before committing to cosigning a loan.

What does it mean to co-sign a loan?

Cosigning a loan essentially means that you are acting as “backup” to the borrower. If the borrower can’t pay back the loan, the cosigner must take on that debt. 

Why would someone ask me to cosign a loan?

The person asking you to cosign probably had their loan application rejected because of poor (or limited) credit history. Lenders are reluctant to lend money to applicants with bad credit. Even if the lenders approve, it is usually at a higher rate of interest to mitigate the higher risks involved. Getting a creditworthy cosigner makes it easier to get approved and at a lower interest rate, too.

How does it make it easier to get approved if I agree to cosign?

It only helps if you have strong credit. Lenders determine loan approvals and interest rates based on the applicant’s credit history. If you cosign, they will approve the loan based on your credit. They may also charge a lower rate of interest on the loan.

Are there any risks in cosigning a loan?

Yes, you are taking a big risk when you agree to cosign a loan. As a cosigner, you take on 100% responsibility for the loan if the borrower can’t pay. If you don’t or can’t pay the money back, the lender may file a legal case against you.

Will my credit score get affected if I agree to cosign?

When you agree to cosign, the lender will first do a hard check on your credit report to establish your creditworthiness. This hard check may result in a small dip in your score. This could make it difficult for you to borrow money in the future because it increases your debt-to-income score. However, this is not a major problem. With continued responsible payments, you can recover from this easily.

The real danger to your credit score is if the borrower misses payments or defaults on the loan. Every time the borrower makes a late payment, it will damage your credit history. If they stop making the payments, your credit score will take a bit hit.

How will I benefit from cosigning a loan?

The primary benefit of being a cosigner is helping a friend or loved one gain a loan. However, if the borrower pays the loan pack on time, the cosigner can earn a small credit boost. 

The borrower, on the other hand, will reap several benefits. It will help them obtain the funds they need. It will also help them build credit provided that they make all the payments on time. This is why you should only cosign for someone you trust wholeheartedly. 

Is it worth the risk to cosign a loan?

Cosigning can help somebody get the funds they desperately need. On the other hand, it puts your credit and your finances at risk. Before agreeing to cosign, it helps to get some perspective on your financial situation. If the borrower stops making payments for whatever reason, can you afford to make the payments? Remember, the lender will come to you for payments if the borrower defaults. If you don’t have sufficient liquid assets to pay off the loan, consider saying no to cosigning. 

Does it matter what the borrower needs the funds for?

Absolutely! It does matter what somebody needs the funds for. And if they are asking you to cosign, you have every right to ask them.

Is the borrower just starting out and looking for an opportunity to build credit? Or does the borrower have damaged credit history resulting from bad financial decisions? You may want to cosign a loan for an individual who is just starting out. However, may want to think twice about cosigning for someone with damaged credit history. It puts your own credit and your finances at high risk.

What does the borrower need the loan for? Is it to cover higher education fees, start a business, pay for some emergency, or buy a high-end vehicle? Times are hard and sometimes people need help to cover their expenses for essentials. It’s good to lend a helping hand if you can afford to. 

Is there any way to get out of this commitment?

A few lenders offer a cosigner release option if certain requirements are met. If there is no cosigner release option, there is no way for you to get out of this commitment. The lender will consider you responsible for the loan until the borrower pays it off in full.

Final Note About Cosigning a Loan

Cosigning a loan is a huge responsibility. You should not enter into a cosigning agreement lightly. Before you sign the loan papers, read extensively about the risks involved. Lenders may handle situations differently from one another.

Also, discuss every little detail with the borrower. Make sure that they understand the risk you are taking in helping them out. Decide how both of you will deal with potential problems. If it makes you more comfortable, create your own contract between you and the borrower.