In some cases, your son or daughter, relative, or friend may have difficulty obtaining a car or student loan or apartment rental because they lack good credit history or have had credit troubles in the past. As a result, they may come to you and request that you cosign their loan or rental application, guaranteeing the lender or renter that you will repay the loan if the primary borrower cannot do so.
As a cosigner, you must complete all loan paperwork alongside the primary borrower. In addition, the lender will likely check your credit history and approve you as a cosigner as part of the process. Therefore, when you have to cosign a loan, you should understand the risks you are taking.
Questions Worth Asking When Cosigning a Loan
- How financially trustworthy is the primary borrower?
- Can I afford to pay this loan in full?
- How important is my credit score to my financial future?
- How does this particular lender communicate with cosigners?
Perhaps the person asking you to cosign is a young adult with no prior credit history but who has a good job and is financially responsible. Cosigning with this borrower can be a great way to help them get their first loan and start building a positive credit history. On the other extreme, the person asking you to cosign may be behind on all her debt payments and is trying to get a debt consolidation loan. In this situation, remember that the primary borrower's past financial difficulties are likely to continue.
If the primary borrower stops making payments, the lender will collect from you. In most cases, you will still be legally responsible for paying the loan even if the primary borrower declares bankruptcy, is permanently disabled or dies. Do not cosign unless you are able and willing to take over the payments for the loan.
All account activity from a cosigned loan appears on your credit report, just as if you were the one who took out the loan. If the primary borrower misses a payment, this missed payment will decrease your credit score. Also, lenders include the loan's monthly payment when calculating your debt-to-income ratio for a mortgage. If you plan to get a new loan yourself in the future, cosigning can be risky.
Often you will not learn that the primary borrower is late on payments until the lender calls you to collect a significant debt. However, some lenders are willing to be in closer communication. For example, they may agree to notify you whenever the primary borrower is late on a payment. Informing you allows you to contact the primary borrower yourself, learn what is going on, and make a plan to get back on track.
Handling a Default on a Cosigned Loan
If you discover the loan you cosigned is in default, which is when the primary borrower is not making payments, first contact the borrower and ask what is going on. Perhaps they forgot to make payments, so your call can provide a quick fix. Often, though, the borrower is having financial difficulties and cannot make payments. In this case, you need to take action to protect your credit score from further damage.
Contact the lender to learn how far behind the primary borrower is and see if the lender can help. Some lenders will issue a forbearance, which allows the borrower to temporarily stop making payments, especially when dealing with significant setbacks like unemployment. Other lenders will forgive late fees if you immediately pay the missed payments.
It is difficult to get out of a cosigned loan once it is in default. Consider asking the primary borrower to refinance the debt independently or with a different cosigner. If the cosigned loan is for a car, another option is to have the primary borrower sell the vehicle to repay the loan. Consider bankruptcy only as a last resort, and be aware that both you and the primary borrower would need to separately declare bankruptcy to get you both out from under the loan.