When applying for a loan or line of credit, you may be told that it would be beneficial to have a co-signer to help you qualify. Having a co-signer on your loan can have both benefits and drawbacks and both should be carefully considered before having them sign on the dotted line.
What is a co-signer, and what are the benefits and drawbacks of having one on your loan?
What Is a Co-Signer?
A co-signer on a loan takes responsibility for the loan, meaning they will be on the line to repay it should the primary borrower fail to do so. A co-signer's obligation is to pay any missed payments or even the entire loan if the borrower defaults.
Often, co-signers are family or friends with whom the borrower has a close and trusting relationship.
Co-signers might be used in the case of a business partnership taking out a loan, lease, or line of credit, but they are most commonly on a loan to help someone with little or poor credit get approved or get better loan terms. Co-signers balance out the borrower's lack of or poor credit with higher credit scores making the likelihood of approval higher.
Sometimes, the interest rate could be very high for a higher-risk borrower, and a co-signer with a high credit score might reduce that interest rate.
Essentially, a co-signer is the higher credit score person you turn to when the approval or better terms are needed for a loan, and they have faith in your ability to repay it. They put their credit and money on the line for you.
Pros of Having a Co-Signer on Your Loan
As you’ve seen, a co-signer could up your chances of qualifying for a loan and there are many pros of a cosigned loan. A co-signer could also be beneficial when partners are both interested in ensuring the loan is paid promptly.
Additionally, someone that might be approved for a loan but have a higher interest rate due to a challenging credit history might see that rate fall with a higher credit score co-signer. Having a co-signer with a good credit record could result in lower monthly payments due to a lower interest rate.
Your credit score could increase if you are approved for a loan with a co-signer and show responsible management of the loan. Your credit report will reflect that a loan payment has been made on time and reflect that on your score.
Cons of Having a Co-Signer on Your Loan
Having a co-signer could have tremendous benefits, but there can also be cons of a cosigned loan if you fail to make a payment.
Foremost, if you fail to make payments, the co-signer is on the hook. Your co-signer could be stuck making the loan payments or paying the entire loan if it goes into default and is called by the lender, which means they demand full payment now.
Can a Co-Signer's Credit Be Affected?
When a co-signer signs onto your loan, they put their credit on the line. The loan amount will also show on their personal credit as an obligation. If the loan is $20,000, their credit scores reflect that they now owe $20,000 more.
When the bank runs the credit check on the co-borrower, it will show as a hard hit on their credit reports, which could have the impact of reducing their scores for some period of time.
Knowing the credit impact if a loan payment is missed is important. A late payment mark tremendously impacts the quality of someone’s credit score. It’s important to remember that negative marks can stay on one’s credit report for seven years. One late payment could do considerable damage to that co-signer’s high credit score that helped you get the loan in the first place.
Finally, if the lender calls the loan and neither you nor the co-signer can pay it off immediately, you both might be forced into bankruptcy, which can destroy your and the co-signer’s credit scores for years. If a bankruptcy trustee orders a five-year repayment plan, it would be five years until the bankruptcy discharge years before you could even start to rebuild your credit.
Taking a loan requires considerable thought, and adding a co-signer requires even more. A lot is on the line if you fail to honor the loan terms.
A Loan Co-Signer Is a Tremendous Consideration
A loan with a co-signer is tremendously beneficial when it comes to qualifying for a loan and receiving better loan terms. At the same time, it is crucial to be confident that you can continue to honor the terms of the loan, or you are risking relationships, your reputation, and the credit and financial health of not just yourself but another.