What is a Co-Signer? | CapWay
- A co-signer is someone who agrees to be financially responsible for a loan if the primary borrower fails to make a payment.
- A co-signer reduces risk tolerance and assures the lender that the loan will be repaid.
- Lenders are required under the Credit Practices Trade Regulation Rule to provide a Notice To Cosigner. It explains what will happen if the primary borrower fails to repay the loan and confirms whether you want to continue the loan after receiving the notice.
What is a Co-Signer?
A co-signer is someone who agrees to be financially responsible on a loan if the primary borrower fails to pay back the loan in full. Although the loan is for the benefit of the primary borrower, a co-signer is equally responsible for the debt owed if the primary borrower defaults on the payments.
Lenders have specific requirements for a co-signer. A few requirements for the co-signer may include proof of sufficient income, a good to excellent credit score (above 670), and stability with employment and residence. When a co-signer meets the lender’s requirements, the primary loan borrower will have a better chance of quick approval, better loan terms, and lower interest rates.
Who Needs a Co-Signer?
Several people may need a co-signer, including teenagers who have yet to build their credit profile or adults who may have mismanaged their credit in the past. For example, a teenager looking to purchase a car but has yet to build credit will need a co-signer. Generally, a parent with good credit will opt to help their teenager get a vehicle by co-signing on an auto loan.
Whether you are applying for an auto loan or a credit card, you need sufficient income and good credit history to be approved for the loan. If a lender expresses that you need a co-signer, you either need more income or lack the credit history to be approved for a loan on your own. Having a co-signer reduces risk tolerance and assures the lender that the loan will be repaid.
Pros and Cons of a Co-Signer
Co-signing can be helpful if you want to buy something that requires a credit check or needs financing. It can also help someone get approved for credit who otherwise wouldn’t qualify. But co-signing does come with risks. One of the risks includes the co-signer having to repay the loan in full if the primary borrower fails to repay the loan.
A co-signer could also risk damaging their credit score or risk not being able to get a loan themselves in the future. Before co-signing, it’s important to thoroughly read the loan terms and know what’s at stake before deciding whether or not to co-sign. Below are some pros and cons of being a co-signer on a loan:
- Helping someone in need who would not otherwise qualify for a loan.
- The primary borrower now has access to lower interest rates.
- The primary borrower also has access to a larger loan amount.
- Co-signing can improve the borrower’s and co-signer’s credit scores if handled correctly.
- It increases your debt-to-income ratio, which could persuade the lender to deny you a loan due to your debt possibly exceeding your income.
- You are 100% responsible for the loan payment if the primary borrower fails to repay the loan.
- Your credit score could be negatively affected if payments are not made on time or at all.
- You risk the lender suing you or garnishing your wages if they need to collect payment.
Co-signers should ask questions and ensure that the potential loan applicant has all their financial ducks in a row. The ideal primary borrower and co-signer will have consistent income, an emergency fund, and pay their bills on time.
Recommended Read: Know Before You Co-Sign
How Co-Signing Affects Your Credit
Co-signing a loan comes with many benefits for the primary borrower. However, a co-signer could take several hits on their credit score. For example, as a co-signer, your credit score will decrease once the lender makes the initial hard inquiry for the loan.
A co-signers credit score will also decrease if payments aren’t made on time. On the other hand, if payments are made on time and in full, then a co-signer’s credit score will increase along with the primary borrower’s credit score.
Co-Signer vs. Co-Borrower
The difference between a co-signer and a co-borrower is their level of investment. A co-borrower is obligated to make payments alongside the primary borrower. A co-signer is only obligated to make payments if the primary borrower cannot do so.
A co-borrower assures the lender that there is more than one source of income available to assist with payment. As a result, the loan benefits both parties on the application. Payment terms have an impact on both parties’ credit scores as well.
Recommended Read: Good Credit Can Make Your Life Easier
Lenders are required under the Credit Practices Trade Regulation Rule to provide a Notice To Co-signer. The notice is issued before signing the final loan documents. It explains what will happen if the primary borrower fails to repay the loan and confirms whether you want to continue the loan after receiving the notice.
Alternative Ways To Build Your Credit
Ideally, you want to get approved for a loan without a co-signer. Below are a few ways to build your credit to help you qualify for a loan.
Paydown or pay off credit cards and loans: Decreasing the amount of debt helps increase your credit score, making it easier to get approved for a loan.
Clean up your credit report: Make sure that your credit report is free of any errors and dispute any unknown charges.
Pay your bills on time: Making monthly payments on time will positively affect your credit score once the lender reports your activity.
Limit the number of inquiries and new accounts: Each time a lender has to pull your credit report, it decreases your credit score, whether you are approved for a loan or not. Likewise, each new account will lower your credit score until you establish a positive payment history.
Recommended Read: Credit is King: How to Navigate the Debt Collections Process
The Money Wrap-Up
Being a co-signer entails some risks and rewards. Both options can have severe consequences for your credit score and finances. Therefore, before agreeing, ensure that you weigh the cost of your relationship with the primary borrower versus the costs and risks of obtaining a loan for someone else.
Even if you decide to proceed with the co-signing process, be financially prepared to pay for the loan for the primary borrower if they experience financial hardship.