What Does Cosigning Mean and Should You Do It?

What is a Cosigner for a Loan?

A cosigner for a loan is someone who agrees to take on shared responsibility for the repayment of a loan if the primary borrower fails to make payments. If you are cosigning a loan, you are a secondary borrower who guarantees to repay the loan if the primary borrower defaults.

In the eyes of the lender, the cosigner is just as responsible for the loan as the primary borrower. This means you’re on the hook if things don’t go as planned.

Why Would I Be Asked to Cosign for a Loan?

When a borrower applies for a loan, lenders use the information from the application to predict with incredible accuracy the likelihood of a borrower defaulting on a loan.

Lenders may require a cosigner when the primary borrower has insufficient credit history, low income, or a high debt-to-income ratio, making them a higher risk for the lender. By having a cosigner with better credit or financial stability, the lender gains additional assurance that the loan will be repaid.

What Are My Legal Obligations as a Cosigner?

When you cosign for a loan, the lender is required to give you a Notice to Cosigner . The Notice to Cosigner advises that by cosigning a loan, you're agreeing to guarantee the debt.

It highlights the potential financial risks, emphasizing that if the borrower defaults, you may be responsible for the full amount, including late fees and collection costs. The notice also warns that the creditor can pursue you for repayment without attempting to collect from the borrower first.

Essentially, your legal obligations for cosigning a loan are the same as the primary borrower.

Keep in mind the lender is not always required to let the cosigner know if the primary borrower is late or has stopped making payments.

For the cosigner, this unfortunately means a negative impact on your credit and additional late fees could be increasing without you even realizing there is a problem.

How Do I Get Released as a Cosigner?

There are only two ways to be released as a cosigner: the primary borrower refinances the loan without you on it or the lender releases you from the loan.

This may not seem too difficult, but it is unlikely. First off, since the primary borrower was required to have a cosigner in the first place, it’s unlikely they will get approved for a loan on their own.

Secondly, lenders are less than likely to release the cosigner from the loan because they already know there is a high probability that the borrower will default.

What are the Disadvantages of Cosigning a Loan?

You may be wondering, does cosigning affect credit? Yes, cosigning a loan can affect your credit score and financial standing.

Beyond the risks of the primary borrower skipping out on the loan payments, your overall debt balance will increase on your credit report. This could have a negative effect when you apply for a loan in the future since your debt-to-income ratio will increase based on the loan amount you cosigned for.

Also, as you read above in the Notice to Cosigner, the lender can use the same collection methods against you as they can with the primary borrower. This could include being sued, having a lien put on your property, or even wage garnishments. And if that isn’t enough, consider the fractured relationships between the friend or family member you cosigned for when things don’t go as planned.

Is It Ever a Good Idea to Cosign?

Now you may be wondering, is there ever a good time to cosign for a loan? The answer is yes. If you’re a parent, it can be a good idea to cosign for an adult child who is transitioning into adulthood.

Young adults just starting off may not have any credit history and need to start building credit. You can help them by co-signing the loan and then having your child, as the primary borrower, create a history of on-time payments for a few years before refinancing the loan into their name without a cosigner.

However, only do this when you can afford to. If you don’t have the means or cash flow to take on the loan yourself, then you should not do it for your children.

The alternative of saving up cash and avoiding a loan altogether is still a great option. This creates discipline, delayed gratification, and financial responsibility, which are great tools to have when managing money.

It’s okay to say “no.”

When a friend or family member asks you to cosign, it’s still okay to say “no.” Sure, it may be difficult, but that moment will pass.

Consider what it would be like to cosign for a loan and discover later that the primary borrower isn’t making payments and now you’re on the hook for the balance, interest, and late fees.

Instead of awkward holiday dinners with family and friends you may have cosigned for, saying “no” now is the much better choice in the long run. If you still feel the desire to help a friend or family member, consider gifting them money instead of lending it or cosigning for it.

Cosigning Specific Types of Loans: Auto Loans, Credit Cards, and Mortgages

Cosigning for different types of loans comes with its unique set of considerations and risks. Here’s what you need to know:

Cosigning for Auto Loans

Cosigning for an auto loan is a common way to help someone starting out building their credit to purchase a vehicle. As we’ve mentioned, cosigning can help the primary borrower get better loan terms or even qualify for the loan.

• Risks of Cosigning for an Auto Loan: If the borrower defaults, the cosigner is responsible for the loan payments. This can be particularly challenging if the car loses value quickly or if it's repossessed, which can severely damage your credit.
• Considerations when Cosigning for an Auto Loan: Before cosigning, be sure you can afford to take over the loan payments if necessary and understand that the car is collateral, meaning it can be repossessed if payments aren’t made.

Cosigning for Credit Cards

People often use credit cards for everyday expenses to help them build credit history. Cosigning can help someone get approved for their first credit card.

• Risks of Cosigning for a Credit Card: As a cosigner, you are liable for any debt incurred on the credit card. Be aware that high balances and missed payments can negatively affect your credit score.
• Considerations when Cosigning for a Credit Card: Monitor the credit card usage and set clear expectations with the primary borrower about spending and payments. Consider setting a low credit limit to mitigate potential risks.

Cosigning for Mortgages

With mortgage rates and home prices skyrocketing in Arizona, it’s becoming more common for extended family members to go in on purchasing a home together. Cosigning is one way to make purchasing a home more affordable, again, if everyone is aware of the risks involved.

• Risks of Cosigning for a Mortgage: Mortgages are substantial financial commitments. If the primary borrower defaults, the cosigner is responsible for potentially large monthly payments, which can be a significant financial burden.
• Considerations when Cosigning for a Mortgage: Carefully evaluate your financial stability before cosigning a mortgage. Understand the long-term nature of the commitment and the potential impact on your ability to borrow for your own needs in the future.

While cosigning can work out nicely for the primary borrower and the cosigner, this unfortunately is not always the case.
Remember, if a lender is asking for a cosigner, their data tells them the primary borrower will eventually need a cosigner to pay the remaining balance on the loan. If you’re considering cosigning, be sure you can afford to take on the payments if it comes to it.