Cosigners are used to secure loans when borrowers don't have sufficient income or credit to take out a loan with their own credentials. The cosigner takes on some of the risk and agrees to pay back the loan if the borrower can't. While cosigners can be used for a variety of consumer loans, they are commonly used for smaller loans or for younger borrowers who don't have their own income.
- What Does It Mean to Cosign a Loan?
Loan Cosigning Explained
Loan cosigners help borrowers qualify for loans that they wouldn't have been able to get on their own. By using the cosigner's credit score and income to guarantee the loan, the borrower can receive more favorable loan terms, like a lower interest rate and a larger loan amount. Cosigners are typically used for auto loans, personal loans, student loans and credit cards. Some common reasons for a borrower using a cosigner include:
- Poor credit or minimal credit history
- Income too low to meet the loan's minimum requirements
- Debt-to-income ratio too high
- Irregular income stream
- Self-employed or short employment history
For the borrower, it's important to be extra diligent when paying back a cosigned loan. This is because late payments and loan delinquency will not only affect the borrower's personal credit score, but also the cosigner's. Late payment fees and other added charges, if left unpaid, can even be charged to the cosigner. As such, both the cosigner and the borrower should have a clear understanding of the loan's terms, payment schedule and consequences for missed payments.
Considerations For the Cosigner
If you're considering cosigning a loan, it's essential that you understand the key risk involved: if the borrower defaults on the loan, then you are responsible for paying it back. This is the primary reason that banks require cosigners for some borrowers—they don't want to take the risk of lending money to a specific borrower, so the cosigner's guarantee helps reduce that risk. Accordingly, cosigners are treated by lenders and servicers the same as the primary borrower, and can even be sued if the borrower defaults on the loan.
The cosigned loan will also be considered by other lenders as a personal liability for the cosigner, meaning that it might be difficult to get another loan after cosigning. Before offering your name and finances as a guarantee, you should be sure whether or not your income and savings will allow you to comfortably pay back the borrower's full loan amount. If not, you should consider whether or not cosigning is a good idea for your own personal finances. Depending on the situation, the borrower might be able to find a different cosigner.
- Assess your personal finances closely before cosigning for someone else's loan
- Missed payments by the primary borrower can have negative consequences for the cosigner
- Cosigning a loan can potentially reduce the cosigner's personal creditworthiness
Student Loans with a Cosigner
College is a large expense for most families, and parents often cosign for their child's student loan in order to secure enough funding. When a parent, guardian or other adult signs for a student's loan, they share the responsibility for making sure payments are made on time. In most cases, payments aren't due until a few months after the student graduates, but it's important to check your specific agreement. For example, if you have a private student loan or unsubsidized federal student loan, you can save money in the long run by making interest payments before graduation.
Cosigning a loan is typically a permanent agreement, meaning that the cosigner is liable for repayment until the loan is paid off in full. However, after graduation, students can apply to have their cosigner released from this responsibility if they meet certain conditions. In most cases, eligibility criteria for release are as follows:
- Graduates are gainfully employed
- Graduates are the age of majority in their state of residence, meaning they can enter into a legal contract
- Graduates display the creditworthiness to repay their loans
- There have been no late or missed payments in the year prior to applying for release
- There have been no loan forbearance or modification programs
If you're interested in applying for cosigner release, contact your loan cosigner for their exact requirements. If you're the primary borrower, you should make sure your credit is in order and that you meet the criteria above.
Auto Loans with a Cosigner
Getting a cosigner for an auto loan can help borrowers receive significantly better interest rates and lower overall monthly payments. However, both the cosigner and the borrower should be clear about repayment expectations for the loan. Auto financers and loan servicers often assess late payments the day after a payment is missed, so it's important to read all the fine print on your contract.
If you're looking to secure an auto loan with poor credit or low income, another way to get approved is to put down a larger down payment. Lenders are more likely to approve credit applicants who have an equity stake in the asset they're buying. If you're struggling to get approved, try saving up for a 20% to 30% down payment. At a loan-to-value ratio of 70% to 80%, lenders are much more likely to extend credit—as they are taking less risk.
Personal Loans and Credit Cards with a Cosigner
For borrowers looking to build credit or cover short term-expenses, taking out a personal loan or credit card with a cosigner can be a helpful first step. As with other loans, the primary borrower and the cosigner should have a clear understanding of who is making loan repayments and when. Obtaining a release from cosigner responsibility is near impossible for these types of loans, so it's particularly important that information is communicated between all parties involved in the agreement—lender, borrower, and cosigner.