Cosigning a loan puts your hard-earned savings and your hard-won credit score at risk.
But how do you say no when a friend or family member you love asks you for help?
Maybe you don't. Maybe you say yes. But be sure you read to the end of this article first. At least you'll then know what you're putting on the line.
What Does Cosign Mean?
Cosigning a loan means that you accept full responsibility to repay the debt in the event it is not paid according to terms.
It's not an inexpensive way to say "I love you" to dear friends or beloved family members. When large amounts are at stake, it can prove very costly. And, worse, it can sour even the strongest relationship.
The point of having a cosigner is to give a lender the assurance that someone with bad credit is good for the debt. A primary borrower who wouldn't otherwise be capable of qualifying for a loan gets the money - and likely at a much lower interest rate - than without that second signature.
So being a cosigner is different from being a co-applicant or co-borrower. With those last two, you're an equal partner with the same rights and responsibilities as your fellows. But a cosigner is an all-purpose backstop.
What Credit Score Does a Cosigner Need?
There's no magic number for the credit score a cosigner needs. But there's no advantage to the primary borrower if your score is similar to - or lower than - his or hers. The whole idea is that he or she piggybacks on your good credit.
So the lender pretends it's lending to you and all but ignores the main applicant's circumstances. And it's going to weigh its chances of getting its money back from you if things go badly wrong. Because it's you that the lender is likely to turn to first.
Here is how FICO breaks down credit score ranges and how likely loan approval would be:
|FICO Score||Likelihood Your Credit Score Could Help Secure Loan Approval|
|<580||Poor. Chances are, your signature would hinder as much as help an application by friends or family members|
|580-699||Fair. You might help a borderline loan application limp over past the post|
|670-739||Good. You could make a difference in seeing an application succeed and may contribute to a more attractive interest rate|
|740-799||Very good. Lenders love you. Sign, and there's a high chance the loan could come through with a great rate|
|800+||Exceptional. You're just showing off now. An approval at an exceptionally low rate is all but assured|
But remember, the more you have in creditworthiness, the more you have to lose. So read on for potential downsides.
Why Cosigning is a Bad Idea
When you cosign a loan (physically, you often cosign the loan application), the lender must send you a letter, warning you of the obligations you're taking on. But you've probably already said yes by then, and backing out at that point could be painful all around.
So let's lay out what you're going to read before it's too late. On its website, federal regulator the Consumer Financial Protection Bureau (CFPB) details (the following is a direct quote) the information such letters must contain:
- You are being asked to guarantee this debt. Think carefully before you do. If the borrower doesn't pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.
- You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount.
- The creditor can collect this debt from you without first trying to collect from the borrower. The creditor can use the same collection methods against you that can be used against that borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become a part of your credit record.
Woah! There's a lot in there. Most importantly, you…
- ... could end up on the hook for more than the sum on the loan agreement
- ... might have to pay all that's owed in one go -- immediately on default
- ... could be chased for payment from the moment of default, even before the person you cosigned for (The lender may well focus on harassing you because it thinks you're the one with the money to pay)
- ... might be sued or go through the humiliation of having your wages garnished if you can't pay the loan in full immediately (Ultimately, you could even be bankrupted)
- ... see your credit score take the same huge hit for a defaulted account that it would if you yourself had been the primary borrower. And it could take seven years or more for all that to drop off your credit history
Why Cosigning is a Bad Idea for the Borrower Sometimes Too
What happens to a loan you've cosigned if you die or go bankrupt? In some cases, it could automatically go into default and become immediately payable in full. And that might often leave the borrower in an impossible position.
Back in 2014, the CFPB highlighted this issue for student loans. Most private ones were cosigned, usually by a parent or grandparent. And the regulator was receiving complaints from borrowers who were facing defaults as a result of cosigners' deaths or bankruptcies -- even when their payments were current and their loans were in good standing.
The CFPB's advice? Get a cosigner release.
Some lenders offer a cosigner release after a specified number of consecutive, timely, monthly payments. But you have to apply for one. The idea is that the borrower has proven that he or she can sustain the loan without the cosigner's support.
Fourteen months later, the Bureau issued a news release under the headline, "CFPB Finds 90 Percent of Private Student Loan Borrowers Who Applied for Co-Signer Release Were Rejected." Ho, hum.
But don't let that put you off. Apply for a cosigner release the moment you're eligible - if the loan agreement says you are. You may be among the 10% of lucky ones. And, if you're not, persistence may reward you.
Alternatives to Cosigning a Loan Depend on Loan Amount
There are alternatives to cosigning a loan, but the sum involved is often critical. If you're asked for your signature on a $5,000 personal loan, you might decide to go ahead - providing you could easily absorb the loss of that amount. Many people in their middle or later years find their personal finances can stretch to that.
But if that's the case, why not just lend the money yourself?
You could ask for the same interest rate as the lender (which would almost certainly be much higher than any savings account yield) and everybody would win.
And if the borrower lets you down, you're going to be no worse off - while not being faced with all the consequences of being the cosigner of a loan when the borrower doesn't make a payment on time, skips one or two, or even defaults.
But the most serious issues arise when you're cosigning a loan for a huge amount: tens or hundreds of thousands on a mortgage or student loan. Even a car loan can be enough to cause real hardship.
Of course, none of this may be enough to deter you. As mentioned above, most private student loans have cosigners. So you won't be alone if you can't say no to a beloved child, grandchild or friend.
How is a Cosigner's Credit Affected?
Cosigning a loan can do damage to your credit if things go seriously bad and the borrower defaults. But let's dig into the detail of what may happen before that.
To be 100% clear, the account is going to appear on your credit report as well as the borrower's. And so should the evolving payment history. As long as everything goes along well, that's not an issue.
Indeed, it might even help your credit score.
Part of that is based on your credit mix, which means having a balanced blend of revolving credit (mainly credit cards and store cards) and nonrevolving credit (installment loans such as mortgages, car loans, personal loans and student loans). So, depending on the existing mix, a new credit account could even make your credit report more attractive to credit scoring algorithms.
So does cosigning hurt your credit? Probably not ... as long as everything goes well.
Risks to your good credit - and how to manage them
The good news stops there, however, because all the loan's monthly payments will also appear on your credit report. A single late payment is typically going to give your score a hit from which it could take months to recover. Multiple overdue payments could cause serious damage that might take years to get past.
And, at the risk of being boringly repetitive, a default after enough skipped payments could bring devastating consequences. At that point, you might…
- ... be sued for the debt in court
- ... see your wages garnished
- ... face bankruptcy
Never cosign a loan and forget it. Monitor the account and your credit score through all the monthly payments. And intervene quickly if issues arise.
Work with the Primary Borrower
One of America's Big-3 credit bureaus is Experian. And it suggests you make absolutely sure that the primary borrower recognizes all the implications of your cosigning:
How Does Cosigning Affect your Credit? Does it Show as a Debt?
"Make sure they understand just how important making those payments on time is to both their credit history and yours. Make sure they fully understand the favor that you are doing for them and the responsibility you are taking on for them. You are taking a risk for them and it could affect you negatively if they don't manage the debt well. Co-signing is something you should both take very seriously."
You got it: Guilt 'em out!
Care for the Relationship Too
But is that enough? Only you can decide, based on your knowledge of yourself and the one you love enough to lend your good credit.
If you have grounds to suspect that person might let you down, say no to cosigning. Because - beyond the financial risk - there's also a risk to your relationship.
Might your friend or relation avoid seeing or speaking to you if he or she feels guilty about the damage to your credit?
Might you end up feeling resentful every time you see a social-media post where that person you cosigned with is out in a bar, or in a restaurant, or taking a weekend break or vacation?
It's appropriate to have these concerns. You may well still think that agreeing to be a cosigner is the right thing to do. But at least you now know what's at stake.