How Co-Signing Works: What Borrowers and Signers Need to Know
Co-signing is a strategy to help get a loan approved. When you add a co-signer to a loan, lenders gain an additional borrower to collect from. Plus, a co-signer’s income and credit scores can boost an application that might not otherwise get approved.
What Is Co-Signing?
Co-signing happens when somebody promises to repay a loan for somebody else by signing a loan agreement (or electronically agreeing to repay). Lenders then evaluate the loan application using credit and income details for the primary borrower and any co-signers. Because co-signers assume responsibility for payment, lenders typically have the right to collect any unpaid loan balance from either person.
Why Lenders Require a Co-Signer
Borrowers need sufficient income and an acceptable credit history to qualify for a loan. In some cases, a borrower can’t qualify individually. For example, the borrower might not have an income that’s high enough to cover monthly debt payments (at least from the lender’s point of view). Low credit scores, problems in credit reports, or a lack of credit history can also cause problems.
Assuming a co-signer has enough income and sufficient credit scores to make a difference, a guarantee from a co-signer can convince lenders to approve a loan.
What Should You Know When Finding a Co-Signer?
Finding a co-signer can be difficult.
Ideal candidates: For starters, you need to find somebody with good credit, or credit scores that are meaningfully higher than yours. Also, the co-signer needs enough income to support your loan payments—as well as any other loans they may already have for themselves. As a result, it’s best to ask somebody who has a long history of borrowing and repaying loans, and who earns at least as much as you do.
Co-signer risks: You also need to find somebody who is willing to co-sign for you. That person takes 100 percent responsibility for the loan if you fail to repay for any reason. That’s a huge responsibility. You could die in an accident, lose your job, or just decide not to pay—any of which leave the co-signer responsible for your debt. If the co-signer doesn’t pay, their credit will suffer, and the lender may take legal action to collect on the debt. Because of that, asking somebody to co-sign for you is asking a huge favor.
For more details, read about Finding and Using a Co-Signer.
If you can’t find a co-signer: If nobody is available to co-sign for your loan, or if you prefer not to use a co-signer, there may be several ways to borrow. For ideas, see Get a Loan Without a Cosigner.
You can build credit: Remember that your current situation might not last forever. Over time, you can build credit, and you'll eventually be able to borrow on your own.
What Should You Know Before Co-Signing a Loan?
Co-signing a loan for somebody is risky.
All of the pain, none of the gain: By co-signing, you take full responsibility for the loan—even though you're not receiving the money, and you don’t have ownership rights. If the borrower can't or won't repay, the burden of repayment falls to you.
Reduced borrowing ability: Co-signing can be risky even if the primary borrower repays the loan. When you co-sign, other lenders can see that you potentially have to repay the debt because the loan appears in your credit reports. Other lenders may include that payment in your debt-to-income calculations and be reluctant to lend to you. Qualifying for a home or an auto loan could be more difficult, even though you're not making any payments on the loan you co-signed for.
Betting against the bank: Banks are in the business of lending, and they're not willing to approve a loan without your guarantee—so you need a good reason to take that risk. Evaluate alternative ways to help without putting your credit on the line. For those ideas and more details, see Before You Co-Sign a Loan.
How to Protect Yourself When Co-Signing
Co-signing a loan is a generous act. You can give somebody a hand, often without spending any of your own money. But it's risky. Several strategies may help you avoid significant losses and damage to your credit.
Evaluate the payments: Start by assuming you will repay the loan yourself. Can you afford to make those payments until the loan is paid off? If not, don’t co-sign.
Get notified: Request duplicates of any communication from the lender, including statements, late payment notices, and other documents. Use a lender that will agree to this arrangement in writing. Also, set up text or email alerts for missed payments and any other important transactions. Get login information to monitor the loan and check in on progress periodically.
Secure a release: In some cases, lenders “release” co-signers from their obligation after two years (or so) of on-time payments from the primary borrower. All other things being equal, choose loans that offer this feature, and be sure to formalize your release as soon as you’re allowed to do so. Tragic events outside of anybody’s control can make you responsible for payment, and it’d be a shame to pay when you don’t have to.
Consider insurance: Find out if the borrower has adequate life, disability, and other insurance coverage in place. If so, verify that those benefits will pay off the debt. If not, consider adding coverage and ensuring that you’re the beneficiary. Short-term coverage may not be expensive.
Don’t let the loan grow: If the borrower stops making payments, it may be best to make payments yourself as soon as possible—you’re responsible for the payments anyway. If payments are late, lenders may charge additional fees and report payments over 30 days late to credit bureaus. Keep things from getting worse than they already are.
Communicate regularly: Check in with the borrower periodically and ask about the loan. Find out if everything is going well, or if the borrower is experiencing financial hardship. It’s better to learn about problems before they result in penalty fees and damage to your credit.