You need money. It doesn't matter why. If you need to borrow money to buy a car, a home, or even pay off your medical bills and you don't have enough credit or a high enough credit score, lenders may recommend getting a co-signer. Before you dive right in and go to friends and family in search of someone with good credit who is willing to put their good name (and good credit) on the line to help you secure the funding you seek, there are a few key details you need to understand. Here's what you need to know about co-signers and what it means to require one for a loan.
What is a Co-Signer?
A co-signer is someone with good credit who agrees to repay your debt if you do not. When you have a co-signer with good credit, lenders will often extend credit to you that you would not otherwise qualify to receive. Sometimes, it can help you purchase a home with a smaller down payment or get a better interest rate on top of the loan itself (depending on how great your co-signers credit happens to be).
If you do not repay the loan, then your co-signer will be on the hook for the loan or put their credit at risk. It's a huge responsibility for them and requires significant trust from you. In other words, this is usually something a parent might do for an adult child or another close family member. You would not ask a coworker or casual acquaintance to do it for you. It's also not something you want to take lightly. If someone agrees to co-sign for your loan, it is a massive show of faith in you and one you should not overlook easily.
Reasons a Co-Signer is Required
Some lenders prefer borrowers to have co-signers for a loan for a few reasons. Some of the primary reasons are listed below.
- Short credit history. Especially common for young borrowers.
- Your credit score is too low to qualify alone.
- Your income is too low to qualify on your own.
- Your debt-to-income ratio or credit utilization score is too high.
As you can see, it isn't always a sign that you've done anything wrong when lenders require co-signers. It could be that you haven't borrowed enough money in the past or that you are just starting out with credit and income and need a little help getting started on your credit journey.
How to Choose a Co-Signer
When looking around among your loved ones and close relations, seeking specific characteristics in your co-signer candidates is essential. Not everyone is a good choice. For instance, you need someone who checks off all the following boxes for your co-signer.
- Good credit score.
- Someone you trust, who trusts you.
- Someone with sufficient financial means to pay the loan if you cannot do so (while you may have the best intentions, the bank will require proof of your co-signers ability to repay the loan if you do not).
Co-signers can be essential for helping you secure funding for important things in life. However, you are asking a lot of someone when you ask them to co-sign a loan for you. Keep that in mind.
Risks of Co-Signing
There are quite a few risks associated with co-signing loans for the co-signer. While the person who receives the funds is supposed to pay the money back, a co-signer guarantees the repayment. This means that if the borrower defaults on the loan or begins making payments late, it will harm the co-signers credit score and may adversely affect the co-signer's credit. If the borrower defaults, the co-signer could be on the hook for the total amount owed on the debt.
How to Protect Yourself as a Co-Signer
The decision to co-sign a loan with someone is a huge responsibility. While it might not be something you are hesitant to do, it should be something you carefully consider, as it can have a far-reaching impact on you if anything goes wrong. As a co-signer, you take responsibility (and some degree of ownership) for the debt incurred.
If the borrower defaults on the loan or gets behind on the payments, it will reflect on your credit score. More importantly, you are taking on the financial responsibility to repay the loan in these instances. If things go sideways, the creditor will come after you for collections. It is up to you to protect yourself.
One of the most important things you can do is ensure you understand the potential consequences of co-signing on your life. The second thing you need to do is to make sure you know what's going on with loan payments so you can keep them from falling behind. After all, staying out of a financial hole is much easier than crawling out of one once you've fallen into it. Finally, don't offer anything as collateral that you aren't willing to lose or pay large sums of money to keep.
Alternatives to Co-Signing
If someone you love asks you to co-sign a loan, you can still help while taking a more negligible risk upon yourself. A few alternatives to co-signing include the following:
- Provide the gift of a down payment to reduce the amount of debt and increase the odds of credit acceptance.
- Offer a loan out of your pocket to help a loved one meet their financial needs.
- Alternative lending, such as peer-to-peer lending, may provide greater flexibility.
Acts like this offer less risk for co-signers while still providing the assistance a loved one requires.