A co-signer is an individual who will assume responsibility for a loan if the initial borrower cannot make payments. Co-signers may assist borrowers in becoming loan-qualified and qualifying for favorable terms, yet they share financial risk. It is important to understand the function of a co-signer and when you would need one prior to applying for a loan.
What is a Co-Signer?
A co-signer is another person—ordinarily a member of the same household or trusted friend—who makes an agreement with you to pay for a portion of the debt when you do not. Should you fail to meet payments on your loan, then the co-signer pays instead.
When Do You Require a Co-Signer?
- Poor Credit History
Lenders look at credit scores when they approve loans. In the event that a borrower doesn’t have any credit or possesses a low credit score, he/she might require a co-signer to be approved.
- Low Income
In the event that a borrower doesn’t have income sufficient enough to satisfy the lender, a co-signer with a steady financial history will increase chances of approval.
- High Debt-to-Income Ratio
Lenders review debt-to-income (DTI) ratios to qualify for a loan. A high-DTI borrower might need a co-signer to minimize the lender’s risk.
- Improved Loan Terms
Even if a borrower is eligible for a loan, including a co-signer with good credit can obtain a lower interest rate and improved terms of repayment.
- No Collateral
For secured loans, the lender might insist on collateral. In the case of the borrower being unable to provide assets for collateralizing the loan, a co-signer can offer extra security to the lender.
Responsibilities and Risks of a Co-Signer
- Financial Liability
The co-signer is liable for the loan by law. In case the main borrower does not pay, the co-signer is responsible for settling the debt.
- Impact on Credit Score
The loan is reflected on both the borrower’s and co-signer’s credit reports. Missed or late payments can hurt the co-signer’s credit score.
- Increase in Debt-to-Income Ratio
The co-signed loan counts as part of the co-signer’s debt, which may limit their future ability to borrow funds.
- Legal Ramifications
If the borrower defaults and the lender sues, the co-signer may face lawsuits or wage garnishment.
How to Safeguard Yourself as a Co-Signer
- Evaluate the Borrower’s Financial Status
Make sure the borrower has a solid income and good plan for repaying the loan.
- Know the Terms of the Loan
Carefully read the loan contract and double-check the sum, payment timeline, and rate of interest.
- Create Monitoring
Request access to the loan statements or establish notifications in order to monitor payments and receive no surprises.
- Keep an Alternative Plan
Think about what you would do with the debt if the borrower doesn’t pay. Emergency funds may need to be set aside.
- Look at Alternatives
Rather than co-signing, look at other avenues like secured loans, credit-builder loans, or other lenders.
How to Get a Co-Signer Removed
- Refinancing the Loan
The loan can be refinanced in the borrower’s name only if the borrower has bettered their credit and income.
- Loan Assumption
Some lenders allow borrowers to assume full responsibility for the loan after meeting specific conditions.
- Co-Signer Release
Certain loans have co-signer release options, allowing removal after a set number of on-time payments.
Conclusion
Using a co-signer can facilitate loan approval by making terms more favorable, but it also poses financial risks for the co-signer. Co-signers should only be approached if a co-signer is truly necessary, and co-signers must understand their obligations before signing. Open communication and careful planning by both individuals can lead to a successful experience in loan repayment.