What does it mean to cosign a loan?
Cosigning is a term we often hear but might not fully understand. Simply put, if you cosign a loan, you’re agreeing to pay the debt if the person you’re signing for defaults. It allows a person with good credit to vouch for someone with little or bad credit, which in turns allows that person to establish or improve their own credit history.
Given that a co-signer can be held completely responsible for paying a loan, why would anyone do it? It generally boils down to the relationship between the borrower and the co-signer, and the two primary reasons are:
- To help someone, especially a child, establish credit. If a young person needs to borrow money – say for school or their first car – they likely don’t have a credit history. While it’s possible to get a loan without established credit, the interest rate is likely to be higher than a borrower with a history would be charged. Oftentimes parents will co-sign these loans in order to help their children start their financial journey.
- To help someone obtain financing. If a person has a poor credit history, it can be impossible to borrow money for a car, housing, or education. If you have a close relationship with someone in this situation, you might be willing to help them purchase these things by co-signing a loan with them.
Are there valid reasons not to cosign a loan? Of course, and they’re pretty big:
- The amount of the loan will be included in your Debt to Income Ratio. (DTI) DTI is calculated by dividing your monthly debt payments by your monthly income. The higher the ratio, the more interest you’ll likely be charged on your own credit. If you’re planning any major purchases that will require a loan of your own, this will result in a higher payment.
- You can’t remove yourself as a co-signer, and you’re not only responsible for the loan amount, but also for any late charges or collection fees the primary borrower might incur if they miss payments.
- Any missed or late payments will appear on your credit report.
What’s the bottom line? If you agree to co-sign a loan, be sure to keep the lines of communication with the borrower wide open. Ensure they understand the importance of contacting you before missing or making a late payment. If they let you know they’re going to be unable to make a payment, be prepared to make it for them or let your credit take the ding.
The views, information, or opinions expressed in this article are solely those of the author and do not necessarily represent the views of Citizens State Bank and its affiliates, and Citizens State Bank is not responsible for and does not verify the accuracy of any information contained in this article or items hyperlinked within. This is for informational purposes and is no way intended to provide legal advice.