A friend or family member who needs help securing a new loan may ask you for help. If they have bad credit or have yet to establish credit, chances are their loan application will be declined. You can help by adding your name to the loan and improving their chances of qualifying. But keep in mind there are pros and cons for you both in this arrangement.
What is a Loan Cosigner?
A cosigner adds their name to a loan application and agrees to legal responsibility for the repayment of the loan amount in case the primary borrower does not pay. A loved one is usually called on to be a cosigner because of their high credit score and clean credit report. The added signature lowers the lender's financial risk, helping the borrower secure an auto or personal loan with lower interest rates and with more favorable loan terms.
Pros and Cons of Cosigning a Loan
The cosigner primarily takes on the risks when cosigning a loan, while the borrower realizes the benefits. The cosigner can help the primary borrower establish a credit history by securing a loan for which they may not otherwise qualify. However, missed payments on the cosigned loan can negatively impact the cosigner's credit.
Before agreeing to cosign for a friend or family member, consider the following risks to your finances.
What’s Not So Great About Cosigning a Loan
You are responsible for the loan. Regardless of the amount and type of loan, the cosigner is responsible for repaying the full amount plus any late fees. You will want to assess your personal finances to be sure you can manage the worst-case scenario of taking over the entire loan and the payments that come with it.
Your credit score will be affected. Your credit report will first be hit with a hard pull when the creditor contacts the credit bureau to request your credit file. Although this is a minor hit, the new loan appearing on your credit report may result in a higher debt-to-income ratio (DTI), inhibiting your ability to qualify for your own loan.
The payment history, including on-time and late payments, will impact your credit score. Your credit score will increase if the loan agreement is met and paid off in full and on time but it will decrease with late or missed payments.
Request a free copy of your credit report from annualcreditreport.com.
Legal Fallout. If the borrower defaults on the loan, the lender may sue and will first try to collect the money from the cosigner. You will be responsible for the cost of the lawsuit and all attorney fees.
Your relationship is damaged. When things go wrong, dealing with the financial consequences of a mishandled loan can damage any relationship.
Stay Positive and Plan Ahead
Cosigning a loan for a family member can help them gain financial independence. You can feel good about supporting a loved one to get a student loan or a car loan to buy their favorite car.
Before signing, develop a communication and payment plan to address and manage any payment issues quickly. Keep your eye on the loan status and periodically check in to ensure timely and accurate payments. You may need to step in and cover a month or two to keep loan payments on track but helping a friend or family member build good credit or re-establish credit can also help build a trusting relationship.
TDECU Loans for Every Stage of Life
TDECU can help you find the right financial program to establish or rebuild your credit. Whether you need a bank account, loan, or credit card, we have competitive interest rates for wherever you are in your financial journey. Contact a TDECU representative today.
Find more information about guarding your financial health in our Advice Center.