In some cases, your son or daughter, relative or friend may have difficulty obtaining a car or student loan or apartment rental because they lack sufficient credit history or have had credit troubles in the past. They may come to you and request that you cosign their loan or rental application, guaranteeing the lender or renter that you will repay the loan if the primary borrower is unable to do so.
As a cosigner, you will be asked to complete all of the loan paperwork alongside the primary borrower. As part of the process, the lender will likely check your credit history as well and approve you as a cosigner. When you are asked to cosign a loan, you should understand the risks that you are taking.
Questions to ask as you decide whether or not to cosign
- How financially trustworthy is the primary borrower? Perhaps the person asking you to cosign is a young adult with no prior credit history, but who has a good job and is financially responsible. Cosigning with this borrower can be a great way to help him or her get their first loan and start building positive credit history. On the other extreme, the person asking you to cosign may be behind on all her debt payments and is trying to get a debt consolidation loan. In this situation, remember that the primary borrower's past financial difficulties are likely to continue into the future.
- Can I afford to pay this loan in full? If the primary borrower stops making payments, the lender will try to collect from you. In most cases, you will still be legally responsible for paying the loan even if the primary borrower declares bankruptcy, is permanently disabled, or dies. Do not cosign unless you are able and willing to take over the payments for the loan.
- How important is my credit score to my financial future? All account activity from a cosigned loan appears on your credit report, just as if you were the one who took out the loan. If the primary borrower misses a payment, this missed payment will decrease your credit score. Also, lenders include the loan's monthly payment when calculating your debt-to-income ratio for a mortgage. If you plan to get a new loan yourself in the future, cosigning can be risky.
- How does this particular lender communicate with cosigners? Often you will not learn that the primary borrower is late on payments until the lender calls you to collect a big debt. However, some lenders are willing to be in closer communication. For example, they may agree to notify you whenever the primary borrower is late on a payment. This allows you to contact the primary borrower yourself, learn what is going on, and make a plan to get back on track.
Handling a default on a cosigned loan
If you discover the loan you cosigned is in default, which is when the primary borrower is not making payments, first contact the borrower and ask what is going on. Perhaps they forgot to make payments, so your call can provide a quick fix. Often, though, the borrower is having financial difficulties and is not able to make payments. In this case, you need to take action to protect your credit score from further damage.
Contact the lender to learn how far behind the primary borrower is and what the lender can do to help. Some lenders will issue a forbearance, which allows the borrower to temporarily stop making payments, especially when dealing with major setbacks like unemployment. Other lenders will forgive late fees if you immediately pay the missed payments.
It is difficult to get out from a cosigned loan once it is in default. Consider asking the primary borrower to refinance the debt on her own or with a different cosigner. If the cosigned loan is for a car, another option is to have the primary borrower sell the car to repay the loan. Consider bankruptcy only as a last resort, and be aware that both you and the primary borrower would need to separately declare bankruptcy to get you both out from under the loan.