Cosigning a Loan
Cosigning a loan is a big responsibility, no matter how much money you have. The cosigner agrees to guarantee the debt. If the borrower is unable to make payments, the lender can recoup the loan balance, late fees, accumulated interest, and other charges from the cosigner. Why would anyone consider serving in this capacity? What kinds of loans require cosigners? What is the worst that can happen to loan cosigners? These are the questions we are about to answer for you.
Why Would I Consider Cosigning a Loan?
There are several reasons to serve as a loan cosigner for someone else. Be aware of these so if someone approaches you about cosigning a loan, you know why they are asking. There is one primary reason many people agree to serve in this important role: to help the borrower establish or improve credit standing. Perhaps a student without any credit history needs a loan to attend college, a child wants to purchase a first car, or a friend needs financial help following a divorce.
When people are unable to obtain financing themselves, having someone guarantee the debt can change lender refusal to acceptance. Helping a person get established from a credit perspective is an altruistic move. Guaranteeing a loan for someone with past credit issues is even more commendable. This single action can put a borrower on the right track financially, positively affecting his or her financial future.
What Are My Responsibilities as a Cosigner?
As noted above, loan cosigners guarantee the debt of the borrower. If the borrower misses a payment, the lender may approach the cosigner for the money. If a borrower defaults on a cosigned loan, the individual who cosigned will be responsible for paying the remaining balance in addition to other charges. This is why experts say that a person should have enough money on hand to repay the loan before cosigning on it.
The amount of a cosigned loan is considered debt of both the borrower and individual cosigning the loan. It appears on the credit report of both people and if it is secured by an asset, this property is subject to seizure. In exchange for cosigning a car loan or other type of loan, individuals do not receive any benefits. This is what makes it such a difficult and complicated decision for many people to make.
What Types of Loans Are Available for Someone Needing a Cosigner?
Both secured and unsecured loans may require a cosigner. A secured loan is guaranteed by not only the individual cosigning but also an asset like a home or car. A written promise to pay is the only thing that guarantees an unsecured loan. Within each of these categories, there are car loans, personal loans, certain types of student loans, and even mortgages.
The level of risk involved varies depending on the amount borrowed and repayment terms. For example, cosigning a student loan carries a high level of risk because student loans are one of only a few forms of debt that cannot be eliminated through bankruptcy. If the borrower defaults on the loan, the individual who cosigned could find his or her financial life ruined if unable to repay the outstanding balance.
What are the Risks and Benefits of Cosigning a Loan?
The main benefit of cosigning a loan is in helping the friend or family member in need. The benefits are mainly to the borrower, who has access to credit otherwise inaccessible and a chance to develop or rebuild the credit score. One of the best ways to improve negative history from a credit standpoint is to use and repay additional credit responsibly. The cosigner helps make this possible for the individual.
However, there are some risks to be aware of before cosign a loan. Cosigning limits the amount of money that the individual can borrow because the cosigned debt is taken into consideration. If the individual cosigning is unable to repay a defaulted loan, the lender can sue this person, file a lien against his or her home, or garnish wages. In many states, lenders may attempt to recover the outstanding debt from the cosigner before contacting the borrower, adding to the risk.
The Federal Trade Commission notes several studies indicating that three out of four cosigners for loans in default are asked to repay the money. Late payments and a court judgment are reflected on the credit report of the borrower and any cosigners, damaging the credit score of both parties. This could limit future credit availability and increase automobile and homeowner insurance premiums. Spouses of married cosigners may also be held accountable for the debt if the couple lives in a community property state.
To Cosign or Not to Cosign?
Before cosigning a student loan, car loan, or personal loan, individuals should seriously contemplate what they are doing and consider the character of the individual asking them for help. People often agree to cosign a loan as a favor to someone in need but find themselves in a very bad situation as a result. It may be difficult to say no to a close friend or family member but in the end, it could be the best decision. On the other hand, people who have the funds to repay the loan should it fall into arrears or default may find it a worthwhile proposition.
Refusing to help someone in this way does not necessarily mean refusal to offer any assistance. Assisting the person with budget development, establishing a savings plan, or identifying other sources of income may prove very helpful. Providing tips on negotiating terms with existing creditors or identifying sources for debt management counseling can also help someone with impaired credit be approved for a loan without needing cosigners.