When you cosign a loan you are taking responsibility for its payment should the primary borrower be unable to pay. The loan will appear on your credit report as your obligation. Cosigning will affect your debt to income ratio and will show up as money you owe on your credit report. Late or missed payments could have an impact on your credit.
You should consider the potential consequences carefully before cosigning a loan, especially if you are considering applying for a mortgage.
What Are the Responsibilities of a Cosigner?
Cosigning a loan may seem like a simple, easy way to help out a friend or family member, but that help could have consequences for you. When you cosign a loan, you are committing yourself to be fully responsible for the loan if the primary borrower fails to pay. This can help that borrower get a loan, or get better terms on that loan, because you take responsibility and ostensibly reduce the lender’s risk.
Remember that you are cosigning because lenders see the other party as a high-risk borrower. That’s why they need a cosigner. When you cosign you are taking that risk on yourself. Surveys show that almost 40% of cosigners end up covering all or part of the loan and 26% report that cosigning a loan hurt their relationship with the other party.
You can’t walk away from your obligation as a cosigner. Unless the primary borrower is willing to refinance without your signature or the loan is fully paid, you’re stuck with it.
Remember that even for honest people with good intentions, things can go wrong. Job loss, divorce, accidents, medical events, natural disasters or other unforeseen events can affect the primary borrower’s ability to pay the loan. If you’re going to cosign you should be willing and able to cover the loan in a worst-case scenario.
How Can Cosigning Affect Your Credit?
When you cosign a loan it becomes your obligation. It will usually appear on your credit report, and it can affect your credit in several ways.
- The total amount you owe and the number of credit lines you have open influence your credit. A new loan with a substantial balance can increase your total debt.
- Late or missed payments will appear on your credit report and could have a significant impact on your credit. If you’re not monitoring the loan you may not realize that payments have been missed until you see your credit dive.
- The greatest impact on your credit will be immediately after cosigning the loan when the balance is largest and no payment history has been established.
Your cosigned loan could ultimately help your credit. Once a reliable payment history is established the loan will make a positive contribution. If you don’t have any other installment loans your cosigned loan could help you establish a more diverse credit mix.
How Could Cosigning a Loan Affect My Mortgage Application?
Your credit score has a major impact on your ability to get a mortgage and the terms you will be offered. If your cosigned loan damages your credit you might have to pay a higher interest rate on a mortgage, which could be a large expense over the life of the loan. If your cosigned loan does serious damage to your credit, you might not be able to get a mortgage at all.
A cosigned loan is your debt, and it will affect your debt-to-income ratio. This ratio does not affect your credit but it is considered by mortgage lenders. Many mortgage lenders prefer to see a borrower’s total debt at less than 36% of their income. Consider your debt-to-income ratio before cosigning.
The impact of a cosigned loan is greatest early in the loan’s lifetime, so you should be very careful about cosigning if you’re planning to buy a home soon.
Consider Before You Cosign
Cosigning a loan is risky but in some circumstances, it may be justifiable. Here are some ways to protect yourself.
- Only cosign a loan for people you know well, and trust.
- Only cosign with a clear understanding that you will be monitoring the loan.
- Get online account access so that you can view statements.
- Arrange to be notified by the lender if any payments are overdue.
- Set aside funds to cover any late payments.
- Discuss the status of the loan regularly with the primary borrower.
- Investigate cosigner release clauses. Some loans, particularly student loans, release the cosigner from any obligation after a certain number of on-time payments. This can be a way to limit risk, or at least limit the duration of the risk.
- Remember that the impact of cosigning a loan is greatest when the loan is new. Once a payment history is established, your credit will recover as long as all payments are made on time. If you’re planning to apply for a mortgage soon, it may not be the right time to cosign a loan.
Cosigning can work if both parties clearly understand their responsibilities and are committed to meeting them. There are still significant risks that you need to consider, especially if you’re planning to apply for a mortgage.