What Does Cosigning Mean and Should You Do It?

Key Takeaways

Cosigning for a loan often can be risky.
Lenders require a cosigner because they don’t believe the borrower can pay off the loan on their own.
Cosigners are just as legally obligated to cover the loan as the primary borrower.
It’s best to cosign for a loan only if you can afford to take over the loan payments.

Has a friend or family member ever asked you to cosign a loan for them?

Before you make any decisions about cosigning a loan, it’s important to understand exactly what you’re signing up for. While it may feel great to help a loved one or close friend who is required to have a cosigner, remember you are putting your own personal finances and creditworthiness on the line.

What is a Cosigner for a Loan?

When you cosign for a loan, you are signing it yourself. This means you are fully responsible for the loan repayment if the primary borrower fails to repay the loan.

In the eyes of the lender, you are 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?

As you may have noticed, debt is the most aggressively marketed product in our culture today. Beyond TV commercials, billboards and radio ads, debt is always an option no matter where you are.

Even when shopping online for something that may only cost $20, you are marketed with a debt product known as buy now and pay later

In addition, 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.

So, if a lender is in the business of selling a loan and a borrower is applying for a loan, then why is the lender still asking for a cosigner?

The answer is because the lender already knows the borrower is highly likely to default on the loan and will need someone else to cover the loan when that happens.

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 states:

Notice to Co-Signer

You are being asked to guarantee this debt. Think carefully before you do. If the borrower does not pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.

You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount.

The creditor can collect this debt from you without first trying to collect from the borrower.

The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, it may become part of your credit record.

This notice is not the contract that makes you liable for the debt.

As you read above, 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?

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, you should 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 option 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 Still 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 to say no right now, 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.

Final Thoughts

While there are times when cosigning works out for the primary borrower and the cosigner, this unfortunately is not always the case.

Remember that the financial industry is data driven to predict our behavior with money — both good and bad.

With that said, if a lender is asking for a cosigner, their data is telling 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.

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Chris Petrie - Money Peach By Chris “Peach” Petrie,
Founder of Money Peach

Chris “Peach” Petrie is the founder of Money Peach. Money Peach partnered with OneAZ to provide free financial education to members across the state. To learn more about OneAZ’s partnership with Money Peach, click here.