What is a Cosigner?
If you need to get a loan to borrow money, but you know you will have difficulty getting approved on your own, you may consider a cosigner. In general, a cosigner agrees to pay an individual's debt if that person fails to do so. Most of the time, an individual requests a cosigner when he or she needs a loan for a major purchase or a major life transition.
Common examples include:
- Motor vehicle purchases
- Student loans
When someone agrees to be a cosigner, the agreement must be in writing and enforceable in a court of law.
The Risks of Cosigning
It is important to point out that when you co-sign a promissory note, you may be taking on a significant financial risk. If the person who took out the loan fails to uphold his or her end of the bargain, the money owed will fall squarely on the shoulders of the cosigner. If you are considering being a cosigner, you must think long and hard before signing on the dotted line. Be sure you understand what you're agreeing to, as well as the potential financial ramifications. The decision to co-sign is a personal and business decision that can affect you for the rest of your life. If a cosigner passes away, the financial obligations are transferred to his or her estate. Now you know what we mean when we say the decision is life-long!
People who need a cosigner typically have bad or nonexistent credit or a low income. For instance, many college students require a cosigner in order to lease an apartment, because most young people have not had the opportunity to establish credit or do not have a steady income. In order to get a loan, the lender will require a cosigner, because the individual is a riskier candidate. The cosigner, in a sense, gives the creditor some peace of mind. If the individual who took out the loan fails to pay, the creditor can go after the cosigner in order to collect the debt.
Having a cosigner also benefits the person taking out the loan by potentially reducing the interest rate. The interest rate could be 10 to 15 percentage points less with a more creditworthy cosigner, because, once again, the lender has a security measure in place.
If any late payments are made on the loan or the loan goes into default, the credit score and profile of the borrower, as well as the cosigner's credit score and profile, will be negatively affected. A cosigner can ask a creditor to agree, in writing, to be notified if the borrower misses a payment or the terms of the loan change. If a cosigner is aware of the payment status right away, he or she can have time to deal with the problem or make past-due payments without having to repay the entire amount at once.
A Major Personal and Financial Responsibility
In general, it is important to keep in mind that being a cosigner is a major personal and financial responsibility. A cosigner is being asked to guarantee a debt, so he or she must be prepared to pay up to the full amount of the loan if the borrower does not pay. Plus, there may be late fees or collection costs that increase the amount owed.
If you want to help out a close family member or friend, and you know you can afford the cost of the loan, agreeing to be a cosigner is truly an act of generosity. In essence, you are standing beside the borrower and giving the lender the confidence to approve the loan. As a result, the borrower may be able to buy his or her first home or afford to enroll in grad school - all thanks to your help!