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    Co-signing a loan: Benefits and Risks

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    Co-Signing a Loan The Advantages and Risks
    Co-signing for a loan can aid the borrower in qualifying however it can impact your credit score as well as your overall financial situation.

    Updated on December 16, 2022.

    Table of Contents

    You may be asked to sign for a loan by your spouse, child or acquaintance, particularly if your credit score is greater than the credit score of theirs.
    But what sounds honorable -- helping someone obtain money to pay for a new house or tuition for college -- can have consequences you may not expect.
    What is co-signer?
    A co-signer is someone who adds his or her name, credit history and financial information to the borrower's loan application, agreeing to be legally responsible for the loan amount and any additional fees, should the borrower be unable to pay.
    Many people require or want co-signers since they are unable to be eligible for the loan by themselves. If you have a solid financial history, co-signing someone with a lower credit score or weak credit profile can improve the chances of getting a loan or getting an interest rate that is lower.
    Contrary to a situation in which two borrowers are equally entitled to the loan, in a co-signed loan, the co-signer has no claim to the loan even though they may be responsible for the repayment.
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    Risks of co-signing the loan
    Co-signing a loan places you in a uniquely vulnerable position. These are the potential hazards to take into consideration as well as ways you can safeguard your finances as well as your relationship should you decide to co-sign.
    1. You are responsible for the total loan amount
    This is the biggest risk co-signing a loan isn't just about lending your good credit reputation to help another person. It's a promise to pay the loan when they're unable to pay them, which includes any late fees or collection costs.
    Before you sign a co-signing contract, look at your own finances to ensure you have enough funds to pay for the loan repayments in the event that the borrower is unable to pay.
    2. Your credit is at risk
    When you co-sign a loan and pay it back, both the loan and payment history are recorded on your credit report as well as that of the lender's.
    In the short run you'll experience a brief impact on your credit score, claims Bruce McClary, spokesperson for the National Foundation for Credit Counseling. The lender's hard check on your credit before accepting the loan will ding your score, he adds, and so could the rise in your overall debt load.
    Most important, though the missed payment made by the borrower could negatively impact your score on credit. Because payment history is a factor, a misstep here can wreck your credit score.
    3. The credit you have access to could be affected
    The potential risk for co-signing for a loan to your loved ones is that you may be denied credit in the event that you request it. A potential creditor will factor the co-signed loan in calculating your debt-to-income ratio and may decide it's too risky to offer you additional credit.
    McClary recommends that you check your credit report frequently after co-signing to monitor your finances.
    4. You could be accused of being sued by the lender.
    In some states, if the lender fails to receive payments, it can attempt to collect money from the co-signer, before proceeding to pursue the principal borrower, as per to Federal Trade Commission.
    To reach this point it is likely that the borrower have fallen behind on several payments, and the debt would already have started to affect your credit. Lenders are likely to consider legal action when they find that the loan is 90 to 180 days past due.
    If something happens that is catastrophic and you're sued due to not paying the bill, you're accountable as the co-signer for the entire cost, including attorney's fees.
    5. Your relationship may be damaged
    The borrower might begin paying on time, in full, toward the loan or credit card with great intentions. But , the financial and personal circumstances alter.
    Children who run into trouble when they make payments on a credit card that is co-signed or a car loan may hide the shortfall from their parents until the situation becomes more dire, which can damage trust between the two families.
    Couples who are going through divorce often have to deal with the financial consequences of a co-signed car or mortgage, says Urmi Mukherjee who is a certified financial counselor at Apprisen, a non-profit financial counseling agency. In such cases it could be difficult to persuade the other spouse to contribute their fair share in the event that the spouse has left the house or renounced the car.
    6. Removal of yourself as a co-signer isn't easy
    If problems arise, the removal of yourself as the co-signer is not always easy.
    The lenders who allow co-signers to be let out of the loan may require a credit verification of the main borrower to ensure they are individually viable to pay the loan on their own. The student loans as well as personal loans generally require a specific amount of timely payments before the lender will reassess the borrower who is the principal to determine if they can make payments on their own.
    Benefits of co-signing on a loan
    The upside of co-signing a loan for someone is obvious You can assist them get student loans or a credit card or other financial product they would not get on their own, or save them the cost of interest with a lower interest rate.
    When someone is new to credit or is trying to improve their finances, having a co-signer with a high credit score and an established credit history is a powerful.
    Some online personal loan lenders permit co-signers so it's worth checking before you apply.
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    Do co-signing on the loan build credit?
    Being a co-signer can improve your credit score in the following ways:
    If the payments are paid on time, it adds to your payment history. If you've got a good score and well-established credit, the effect may be minimal compared to the risk to your score should the borrower fail to pay.

    There's a chance that you'll get a little advantage if your credit score improves. It's beneficial to have the option of both installment loans (with regular payments) and revolving accounts (like credit cards).

    The person you co-signed for may build credit through these ways:
    It can assist them to qualify for credit that they would otherwise not be able to get, while also boosting a thin credit file.

    Making on-time payments on the account can build an impressive track record of payments.

    How to protect your credit when you co-sign for a loan
    Before you co-sign, ask whether the lending institution knows what their rights and responsibilities and what you'll do in the event of a payment issue.
    Additionally, you should solicit the primary borrower to grant access to the loan account, so that you can track payments, says Byrke Sestok, a certified financial planner with the New York-based Rightirement Wealth Partners.
    "It's not an issue of trust, but problems happen," Sestok says. "If you discover in the initial month somebody is experiencing difficulty paying back the loanand not being able to pay back the loan take action."
    To prepare for these situations create a contract between the co-signer and borrower prior to signing and in writing, which defines expectations for each of them, McClary says. Your private agreement will help in settling mismatched expectations, he adds.
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    Alternatives to co-signing on a loan
    If you're not willing to co-sign on a loan There are other options available to the borrower
    Consider a family loan If the person who is borrowing is hoping to get a family member co-sign for them, they could choose to do so instead. A family loan does not require a third-party lender, so there's no formal application or approval process, but it must be accompanied by an official, signed arrangement between two of the parties defining the conditions. Family loans can help borrowers get less expensive loans and avoid lenders who are predatory, but they still expose the finances of a person else to risk should the borrower be incapable of repaying the loan.

    Offer collateral: A borrower might be able to offer large-ticket items such as a vehicle or savings account as collateral on the loan. This is referred to as collateral and comes with its own risk. If the borrower is unable to pay back the loan, they will lose whatever asset they're pledging.

    Online lenders that work specifically with applicants who have bad credit. These lenders are less strict than banks and they will consider other factors other than credit score. However, the interest rates of online lenders could be very high when you have poor credit and annual percentage rates typically above 20%.

    About the author: Jackie Veling covers personal loans for NerdWallet.

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