It's no secret lenders reward more creditworthy customers with better interest rates and sometimes even fewer fees. So if you have poor credit (or no credit history), having a more creditworthy individual co-sign when applying for credit can be beneficial. But whether you're a borrower or a co-signer, it's important to understand co-signing before you put your signature on the dotted line. Here are some crucial questions to help you understand how it works.
What is co-signing?
Co-signing means that two parties are applying jointly for a loan. The individual who is intending to use the loan is known as the borrower. The person who is helping them secure the loan is called the guarantor. Being a guarantor involves more than merely vouching for the other party. As a guarantor, you take on the financial responsibilities of the loan. If the borrower doesn't repay the loan, you'll be responsible for doing so.
What is your responsibility as a co-signer?
Once you co-sign a loan, you assume all the financial responsibilities of that loan. That means if you co-sign for a car—even if you never drive it—you're still liable if payment isn't received by the lender. This can include the full amount of the debt as well as any late fees or collection costs. It's important to seriously consider whether you're willing to put your own financial well-being at risk for the loan.
When does it make sense to co-sign?
There are a number of occasions when co-signing a loan may make sense, such as when an individual may not be able to obtain a loan without help due to poor or nonexistent credit history. Parents may need to co-sign a student loan for their child, who has no credit history. However, be wary about co-signing with people who may be only a part of your life temporarily. Even after you part ways, your loan obligations will remain.
How does co-signing affect your credit?
As the borrower, this is a great opportunity to improve your credit. You may be able to significantly improve your credit with regular on-time payments of the loan, so it's important to be diligent about payments. If you fail to meet your obligations, your credit will suffer—as well as that of your guarantors. As a guarantor, be aware that co-signing for a loan may make it more difficult to get a loan of your own approved. The debt will be reflected in your credit and may make it appear that you have more debt than you can safely handle. If the borrower is late on payments, it will also reflect poorly on your own credit. You're putting your own credit at risk by being a co-signer, so be careful to consider whether the risk is worth the benefits.
The bottom line:
Choosing to co-sign a loan is a major commitment. It links the borrower and guarantor for the life of the loan. It's important to consider whether the borrower can handle payments. As a guarantor, you don't want to co-sign a loan that you don't have the ability to repay if the borrower fails to do so.