Why Being a Cosigner on a Loan is a Bad Idea
Shakespeare already said it: “Do not lend or borrow; because whoever lends often loses the friend and the loan”. This might sound cliché, but it is not.
Four hundred years after this Shakespeare’s quote, people are still debating whether or not to help a loved one by lending them money or as guarantor on a loan. Maybe you want to help your son get a college loan at a better rate. Or you want to assist his widowed mother with refinancing her mortgage. But, before you cosign anything, make sure you understand the risks and benefits involved.
These are just a few of the things that can go wrong and some questions to ask yourself before committing to being a guarantor. Because remember that you are also committing your good credit – to what could be a multi-decade of commitment.
First, let’s make one thing clear. You need to understand that the main reason you are asked to be a guarantor for a loan is because lenders believe that the borrower may not be in compliance. Becoming guarantor you guarantee that you will repay the entire loan if the borrower fails to do so. – plus late fees or collection fees.
Who Is A Cosigner?
Many people need a cosigner to be able to obtain a mortgage, vehicle or personal loan. The reason being that they have no credit or the one they have is “bad”. If you need a cosigner to obtain a loan or a friend asked you to be a cosigner on your loan, you must be very careful. As we said, a guarantor is legally obligated to pay the loan in full.
Banks or financial entities request a cosigner from people who have no credit history. It’s also true for people whose credit score is low. In this way, they make sure that someone will pay the loan. In many cases, the cosigner is typically a family member. This person could be a parent, sibling or cousin who will agree to pay off the loan, if the borrower is not able to. The lender might need the cosigner; in the event that the borrower does not have enough income to substantiate the loan. In doing a joint loan signing with a cosigner, the borrower might have a reduced rate of interest.
The person who serves as guarantor has the same responsibilities as the borrower. That is usually established at the time of granting the loan. The only difference is that one receives the money and the other assumes the guarantee.
The bank generally requires a guarantor or guarantor when the loan applicant does not show fiscal responsibility that guarantees his solvency or ability to pay against assumed debts. But, of course, the guarantor must meet several requirements. It includes being of legal age with an excellent income history to support their ability to pay. It can also be having assets such as businesses, properties or vehicles. Those, in case of default by the principal debtor and the guarantor, are used to cover the total of the loan acquired.
Another requirement that banks take into account is the stability of the guarantor. That is if the person with solvency to face the debt also has economic stability in the short term. The person also has to show years on the job, which is part of the economic stability. The aim is to demonstrate that they won’t lose their job or main source of income. No lender is going to offer loans with no job. If with a job, it has to be proven that it is a stable job.
Why Not Be A Cosigner?
There are some reasons why you should think carefully about not being a cosigner. If the principal debtor defaults on payments for any reason, the cosigner will be held liable for the missed payments. The lender can sue the guarantor for interest, late payment of costs, and collection of attorneys’ fees involved in the collection. If the principal debtor is going through difficult financial times and is unable to make payments, and the cosigner defaults, the lender may also decide whether to garnish the guarantor’s wages. If there are outstanding payments, or the principal debtor does not make payments on time, this can affect the credit score of the person guaranteeing the loan.
The Risks and Conflict
To avoid missing or late payment that may affect a guarantor’s credit rating, the cosigner must ensure that payments are made on time. In case the principal debtor is unable to pay on time, the cosigner must make the payment. It is not uncommon for the cosigner to contact the borrower, if he or she is not paying on the loan. Sometimes, it can cause conflict and friction between the two, if not handled delicately. If the cosigner makes payments for the primary debtor, the only way for the cosigner to get the money back is by suing the debtor. This leads to the next risk. One more thing to consider is that some lenders will garnish your wages, if the borrower defaults on the loan.
The Damage and Inconvenience
Cosigning can damage the relationship between the principal debtor and the cosigner. The joint signature requires a high level of confidence that the principal borrower will be able to make loan payments. Not only that he will pay, but that he will pay on time throughout the life of the loan. Sometimes lenders will deny a loan if the person has a lot of debt. Joint signing for student, car, or mortgage loans can add a significant amount of debt to the cosigner. If the guarantor thinks they will need to apply for a larger loan after cosigning, the cosigner may be rejected. This is something the cosigner should take into consideration.
Unforgiving Loan Debt
It is difficult to withdraw from a jointly signed student loan. If the principal debtor files for bankruptcy, the student loans will not be forgiven. The cosigner may still be responsible for all loan payments to the principal debtor. If the lender forgives the loans, the IRS may consider the remaining loan amount as “debt forgiveness income”. This means that the cosigner will have to pay taxes on the loan amount, as if it were income.
Why Be A Cosigner?
Although being a guarantor does not only affect credit, it can also certainly be beneficial. However, the same way the credit report and the guarantee remain in your history, it will look good if said credit is paid correctly and the borrower’s credit history is commendable. It works as if you put your credit reputation on the line for that person. In which case if he or she does well, your recommendation is valuable. Therefore your credit reputation stays intact and benefits you in more ways than one.
A cosigner who has good credit is able to get a lower rate of interest for the loan. If you are cosigning for a family member, then this is going to be highly appreciated. As a repayment for the favor granted by the cosigner and the fact that the interest rate is lower, the borrower will usually go out of his or her way to make sure that payment is made on time to maintain the cosigner’s credit status.
Who Needs A Cosigner?
A guarantor can assist you with securing a loan as a borrower. Lenders offer loans for anyone. However, not qualifying is a reason you need someone to sign the loan with you. In most instances, when you have someone signing on to a contract or loan, you would be potentially able to:
- Get the interest rate lowered, if you are taking out a loan on a car or home
- Get the monthly payments reduced for a car loan or home loan
- Have to pay a lower amount for security deposit for renting an apartment or house
- Obtain a lower rate of interest on a student loan
Whether you are trying to get a car loan, home loan, private loan, investment loan or student loan, lender will check your credit score. If you don’t have sufficient credit, then you are going to need someone to sign onto the loan with you. This person will need to meet the lender requirements that you don’t meet.
The person who has just started a new job is also a candidate for a guarantor. Let’s say you just relocated and you landed a job, but want to rent an apartment with low credit score. In that case you may not qualify as an applicant or the landlord won’t take you seriously. However, if you get a guarantor with years on the job and decent income, you could be given the opportunity. Indeed, it would automatically make you a qualified applicant.
Although it is not recommended to be a guarantor for anyone, here are some guidelines. Take them into account in case you plan to do so:
- Analyze the person’s ability to pay. The guarantor must know the income and expenses, goods and assets of the person requesting financing. This to be sure whether they can pay or not.
- Insolvency or death. In the event that the principal debtor does not cover the debt due to insolvency, death or any other reason, the person responsible for paying is the guarantor.
- Know your credit capacity. When you are a guarantor, the chances of being granted new credit or the amount you request may decrease.
Obviously there is no recommendation that can save you from a bad faith loan where you served as a guarantor. However, there are some aspects that can help a little.
1. Look at the borrower’s financial habits:
First, look at the financial habits of the person you are serving. If you notice that they are someone with a lot of debt or constantly bankrupt, they may not be able to respond very well financially to a new loan.
2. Look at the purpose of the credit or loan:
This is quite relative. However if you analyze their financial habits and know the reason for the loan you can make an approximation of the real need to commit. More importantly you can approximate the importance that the person will give to make such payments.
3. Make sure you know the borrower perfectly
Try not to serve as a guarantor for strangers or distant friends. Obviously the reason is you don’t want the person to easily disappear leaving the debt behind.
There is no formula for predicting what will happen in the future. So try to stay out of these situations unless absolutely necessary.
As a guarantor, you must know the purpose of the debt, the type of debt, its terms and the reason why the holder needs to resort to it. It is important that you understand your legal and financial obligations. Additionally, read the loan agreement. Make sure you know if the debt will be collected from you even after the sale of the collateral.
For more details on what is involved in becoming a guarantor and how it will affect your credit, visit the Goalry online platform and the Creditry store. You will be highly informed.
If you are looking for a loan, checking the APR based on your current credit score before contacting a friend. Sometimes, it’s easier to apply by yourself and will have a better impact on your credit score a long as you pay it off on time. To help you when looking for a loan, we partnered with HiFiona and developed the widget below. It shall give you a good overview of what you could get from trusted lenders:
Cheryline Lawson is a personal finance writer who lives in Fort Lauderdale, Florida with her husband and two boys. She has worked as a mortgage broker and loan processor in the most recent past. She shares a lot of her experiencing in financial planning, real estate investing and budget advice with national media outlets like GoBankingRates, Intuit, Bustle, Buzzfeed and CBS News. Ms. Lawson is a graduate of Broward College in Florida. She came into her own as a mortgage broker after realizing so many people need help to get into their first home. She has a passion for helping others, especially those who need financial advice to use in their daily lives.