Co-signing happens when somebody guarantees a loan for somebody else. For example, you might apply for a loan, and your parents promise the lender that it will be repaid – whether by you or by them – when they co-sign. The co-signer “stands beside” the borrower so lenders are more confident about approving a loan. Why are they so confident? There are now two people responsible for repaying the loan – and at least one of them (usually the co-signer) looks like a safe bet.
A co-signer makes a loan application more attractive to lenders. When anybody applies for a loan, lenders try to figure out whether or not they’ll get their money back. This is done by reviewing the applicant’s credit scores, debt to income ratios, and other factors. If credit scores are bad and income is low (or nonexistent), the loan will not get approved – unless a co-signer is involved.
After a co-signer is added to a loan application, the co-signer’s credit scores and income become part of the lending decision. So, if a co-signer has strong credit scores and plenty of income to repay the loan (those are the only types of co-signers that make sense), the loan is more likely to be approved.
In an ideal world, the actual borrower (not the co-signer) repays the loan. They make monthly payments as required, and the co-signer is mostly unaffected by the transaction. However, if the borrower fails to pay, lenders ask the co-signer to pay. Co-signers are often surprised to find that if the borrower defaults, co-signers are can responsible for 100% of any unpaid balance.
How Borrowers Benefit
The benefit to borrowers is fairly obvious: they get a loan when they otherwise would not be approved.
If you’re a borrower, co-signing is the best thing in the world. You may want to buy a house or pay for school, but find yourself unable to get the funds you need. Your credit might be in bad shape, or maybe you’re a student who has not had a chance to built credit and does not have any income to speak of – either way, lenders will turn you away.
But finding a co-signer gives you the borrowing strength you need. Your co-signer vouches for the loan and assures the lender that there’s nothing to fear. You can borrow at a decent interest rate and avoid predatory lending products because you (due to your co-signer) are a safe bet.
Finding a Co-Signer
Who can you use as a co-signer? You should generally start with the three F’s: Friends, Family, and Fools. You’ll need somebody who will take an interest in your cause and who knows you. Think of people who believe in you and understand how hard you’ll work to repay the loan. Co-signers take a risk by helping you, so you can’t expect everybody you know to do it – they may not be able to afford the risk to themselves and their family. That’s why it’s a good idea to start with family – they know you better than anybody – and with people who are truly on solid financial ground. Your parents may want to help you get started with credit, your friends may want to give you a hand, or another supporter may believe you can pay off the loan if you can just get it.
You can also try to get a loan without a co-signer.
After You Get the Loan
Once you find a co-signer, you need to be responsible. This person is doing you a huge favor. They’ve made something possible for you that you could not make possible on your own – don’t let them down. If you fail repay the loan as agreed, your co-signer’s credit will suffer (and yours will too).
What Risks does a Co-signer Take?
Co-signing for somebody is a generous act. People are often surprised how much risk they take when they co-sign, so it’s important for people on both ends of the deal to understand what’s at stake.
First, a co-signer is fully responsible for the loan. If the original borrower fails to pay, the co-signer is next in line (and the lender will certainly come knocking).
Because co-signers are responsible for loans (even though they might not ever make a payment), their credit is affected. If a co-signer wants to borrow in the future, lenders will see that the co-signer could potentially have to pay off an extra loan, and that might be the difference between an approval and a rejection.
Finally, if a co-signer is unable or unwilling to repay the loan, their credit will suffer. It’s as if they got the loan themselves – if it doesn’t get repaid, the missed payments will be reported to credit bureaus and the co-signer's previously strong credit will weaken. This can also be a problem if the borrower misses a few payments without the co-signer finding out about it: the co-signer might not have to pay anything, but those missed payments will affect her credit.
If you’re considering co-signing, be sure to read Before You Co-Sign a Loan for more information.