Everyone needs a helping hand every now and then. And that’s a good thing. Be it a family member, a neighbor or a stranger, spreading good cheer makes life better for everyone.
But if you’re asked to co-sign on a loan, should you?
Who Can be a Co-signer?
Many times a borrower receives a mortgage denial due to a negative or limited credit history or not enough income. These situations can often be solved by a co-signer.
A co-signer is a third party that agrees to be just as responsible for the repayment of the loan as the primary borrower. The primary borrower will receive the monthly statements and make the monthly payments, but the co-signer is ultimately responsible for the monthly payments in the very same capacity as the primary borrower.
The co-signer can be anyone with an established credit history but most often is a family member such as a parent or grandparent. The co-signer won’t typically receive any monthly statement directly from the creditor nor receive any notices at all unless the account becomes delinquent.
When you co-sign on someone else’s note, you’re providing the little lift that someone else needs in order to finance a purchase.
Say that your daughter wants to buy a new car but the dealership won’t give her a loan with the best terms unless she can provide a co-signer, namely you.
You agree, so your income and employment history as well as your credit will be reviewed in the very same manner as if you applied for a car loan for yourself.
Your daughter gets approved, has a new car with payments she can afford. You helped when help was needed.
Downsides of Co-Signing
On the flip side of being a good parent is what can happen that’s not all that favorable to your profile. When a late payment is made, not only is the information reported to your daughter’s credit report but your credit report will also show a late payment being made.
Many times, a co-signer won’t even be aware of a pending late payment until it’s too late. The daughter may have received some collection calls and late notices from the creditor, but unless you ask to receive copies of all statements and notices that your daughter receives you might be completely unaware of what’s going on.
Each time a late payment is recorded, your credit scores will suffer. In fact, any account that you agree to co-sign for will remain on your credit report for at least seven years after the most recent activity.
Co-Signing Affects your Future Loans
Another issue to address is how the additional payment on the co-signed loan will affect your own debt-to-income ratios. Even though someone else has been making the payments on time, every time, that monthly payment will be added to your personal debt calculations when you apply for another loan.
If it’s a car loan, typically the payment won’t be that big. But if you co-signed for something like a mortgage, you could be severely limited if you go to buy a second home or investment property.
It could be a big bummer if you found a great value on a rental property, only to find out you can’t finance it because you co-signed on a loan. In this way, co-signing could put a damper on long-term investment plans and your retirement.
Before Becoming a Co-Signer You Should…
Some lenders will agree to not count that debt against you if you can provide evidence that the primary borrower has made the monthly payments without any assistance from you. This is typically done by providing copies of cancelled checks drawn against the other parties’ checking account. Not all lenders allow a co-signed payment to be ignored in this fashion but many do.
When agreeing to co-sign, make sure the primary borrower can afford the monthly payments without any help from you. Compare the borrower’s gross monthly income with all monthly debt, including the new loan payment. Total debt should not exceed 40 percent of the borrower’s gross income.
Take a look at the borrower’s credit report as well, if there is any recent negative credit activity, that should give you pause. And finally, should you decide to co-sign, ask that the borrower refinance the loan within 24 months to remove you from the note and qualify individually.
Also make sure that you have enough income to support the co-signed loan and any future loans you plan to take on. Remember, if the person you co-signed for stops paying the loan, you become 100% responsible.
Helping those by co-signing allows borrowers to establish a solid credit history, and is relatively common among family members. Just understand the implications before moving forward.