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5 Reasons to Not Cosign a Loan
Your 18-year-old asks you to help them by cosigning a personal loan — what should you do? You want to lend them a hand, but you’re also right to think twice. Cosigned loans may not be the best idea for either of you. Keep reading for our advice before cosigning a loan for a friend or loved one.
What is a cosigner?
Having a cosigner can help someone get a loan if their credit is limited or they have a bad credit history. Lenders may view the loan as less risky because there’s a second person responsible for payments.
And that’s the catch: As a cosigner, you’re playing back-up on the loan. You might not be called into action, but if the original borrower fails to pay, it’s up to you to make monthly payments. Usually, the cosigner is a parent or guardian of the intended borrower, but it doesn’t have to be.
How cosigning works
Typically, borrowers only ask someone to cosign a loan if they have a strong relationship with you. Entering into a cosigning partnership with someone you barely know is a bad idea.
If both parties agree, the borrower will let the lender know they plan to use a cosigner. Next, they’ll gather the cosigner’s financial information and give it to the lender so the lender can adjust the details of the loan. Finally, the cosigner has to attend the signing or close of the loan with the original applicant.
[ Read: Should You Co-Sign a Loan? ]
When cosigning makes sense
Cosigned loans can work well when your kid needs student loans for school. When you cosign with your child, you’re likely helping them get a lower interest rate than they could have gotten on their own. As long as you come up with an arrangement for repayment that works for everyone, you can help your child save significant money while they repay their student loans.
Similarly, if your child or a loved one with poor credit needs to buy a vehicle, it can help to have a cosigner. Young people typically don’t have a lot of credit history, which can make it impossible to get a car loan. Or if your loved one has a bad credit score, a cosigner can help them to get a loan or get a lower interest rate — just be sure they’ll be able to make the payments so the burden doesn’t fall to you.
The same is true if your child or loved one needs to move to a new apartment but can’t qualify for a lease on their own. A cosigner promises to pay the rent if the original tenant stops, so having a cosigner can make the applicant more appealing. Again, you’re playing back-up, which proves to the landlord they won’t be losing money on this tenant.
Things to consider before cosigning
Are you wondering why not to cosign a loan? Before you become a personal loans cosigner, take a look at our top reasons why you might hold off.
You’re on the hook for the whole loan
Whether or not you want to cosign for a loan might depend on how much the loan is for. A $3,000 loan should take less consideration than a $100,000 loan. The amount of the loan is vital to consider since you are responsible for the entire thing as a cosigner. Also, it’s difficult to get your name off the loan until it’s totally paid off.
It’s a possible credit risk
If the person you cosigned for stops making regular payments, those missed payments will show up on your credit report. The most significant impact on your credit score is your payment history, and even one missed payment can stay on your report for years and damage the score you have worked so hard to build up.
You’ll need to qualify for other loans soon
Before hopping onto any cosign loans, think about your future. Are you planning to apply for a loan in the coming years? Your debt-to-income ratio matters to lenders, and once you cosign a loan, you take on more debt than you had before. Thus, if you’re planning to apply for a new mortgage anytime in the future, having more debt can make it harder to qualify for a low interest rate.
Your relationship could suffer
If your child or loved one stops making payments, your relationship could become strained. Before you cosign a loan, make sure they are responsible enough to handle the loan. Then write out a plan of action for payment, and communicate monthly.
You won’t see the perks of the loan
If you cosign on something like a car loan or a personal loan for your friend’s home rehab project, you won’t see the benefits in your own life. You don’t get to drive the car or eat in the new kitchen. Instead, you’re helping someone else. Lending a hand to a loved one may be reward enough, but make sure the drawbacks aren’t worse than the feeling of satisfaction you’ll get.
Alternatives to cosigning
If you’re the person looking for a cosigner, consider these options instead:
- Increase your credit score: Instead of relying on a cosigner, try to wait until you have built up better credit. That way, you might be able to qualify for a loan without a cosigner.
- Put down collateral: If you have a car or a home you can offer the lender, that could work as collateral. Keep in mind that the lender could come after your car or home if you stop making payments. But if you’re confident in your ability to make payments for the life of the loan, putting down collateral can make your loan look less risky to the lender.
- Turn to a bad-credit lender: Some lenders will give you a loan even if you have bad credit. The catch is that you’ll typically pay a higher interest rate. Try to steer away from payday lenders, which aren’t the same thing.
- Save up money: If you can, save up more money that will allow you to make a larger down payment or take out a smaller loan. You’ll be more likely to qualify for a loan this way.
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