Cosigning A Loan-Understanding The Risks & Potential Benefits
A cosigner is a person who agrees to pay the borrower’s debt should he or she stop paying on the loan. Cosigning a loan provides you with an opportunity to help out a friend or family member obtain a loan. Cosigning on a loan can provide you with a good feeling in helping someone else; however, there are various risks involved with cosigning that you will need to consider before signing your name on loan documents.
Why Cosign A Loan?
- It can help a friend or family member improve his or her chances of getting a loan approved. This is especially true in instances where the borrower has little, no, or poor credit.
- Cosigning a loan can help your friend or family member build credit.
Sometimes it can be difficult to get a loan for people with little or no credit, because financial institutions like to have some sort of credit history to review before approving a loan.
- Being a cosigner on a loan has the potential to improve the cosigner’s credit score.
Cosigning on a loan has the ability to increase your credit score if the borrower makes all his or her payments on time, every time.
Things To Consider Before Becoming A Cosigner
Before you sign your name on any loan documents, make sure you fully understand the risks associated with being a cosigner.
- You Will Increase Your Debt-To-Income Ratio.
Your debt-to-income ratio will increase by becoming a cosigner on a loan. If you have a lot of other credit card debit or loans such as an auto loan or a mortgage, you will want to approach cosigning with caution. Your debt-to-income ratio is the percentage of your debt payments in relation to your income. Lenders look at your debt-to-income ratio when you apply for a loan online. A low debt-to-income ratio displays that you have a good balance between debt and income. Generally speaking, financial institutions like for this number to be low, and the lower this number, the higher chance you have of being approved for a loan. There are many tools you can use for free to compute your debt-to-income ratio, such as Bankrate’s debt-to-income ratio calculator. Before cosigning on a loan, make sure to check your current debt-to-income ratio, and compare how it would be impacted by cosigning on a new loan. Also, be sure that you will not be taking out any additional debt yourself if you do plan to cosign on the loan, because being a cosigner could decrease your ability to obtain new credit.
- In Many Instances You Can’t Remove Yourself As A Cosigner.
Keep in mind that once you sign the loan documents, oftentimes you cannot remove yourself from that loan. In most instances, once you sign the loan documents, you are tied to that debt until it is paid off. However, there are certain instances where a lender may include a cosigner release clause in the loan agreement. Make sure to ask the financial institution if they offer such a clause before you make the decision to cosign.
- Your Credit Score Could Be Impacted.
Keep in mind that cosigning on a loan does carry the potential for your credit score to decrease should the borrower skip payments or default. Remember, that late payments on this loan will appear on your credit report. Payment history makes up 35% of your credit score. If you have worked hard to build a high credit score, you do not want all of that hard work to be ruined by missed payments on someone else’s behalf. The ability for the borrower to pay on time, every time should be a major factor in helping you determine if you will be a cosigner on the loan.
- Evaluate Your Ability To Pay.
Before you cosign on a loan, evaluate your ability to pay on the loan should the primary borrower default. Make sure you would be able to comfortably make payments on the debt with your current financial responsibilities. Above all, remember that cosigning on a loan makes you financially responsible for the loan should unforeseen circumstances arise with the primary borrower. You don’t want your personal finances to be negatively impacted should something go wrong.
Does Cosigning A Loan Make Sense?
Ultimately, cosigning a loan is a personal decision that needs to be handled with caution and care. Cosigning a loan can be a great thing to help another person get financing, but it should be evaluated on a case-by-case basis. Above all, you want to protect your own finances and credit score. Thoroughly analyze all potential outcomes before cosigning a loan, and make a decision based upon what is best for you and your financial future.