Cosigning a loan is not uncommon in the current financial climate. People cosign a loan for their family members, siblings, children, friends and others. Helping someone get an approval on their loan application just by cosigning can feel like a rewarding experience. But, it does not come without its risks.
Before you cosign a mortgage for someone, there are various things you need to consider, including how cosigning a loan will affect your own finances.
But first-
What does cosigning a loan mean?
In a standard situation when a person decided to apply for a Personal Loan, or any other loan for that matter, there is an agreement between the borrower and the lender stating the terms of the loan. In the case of a cosigner, the agreement is also signed by a third person, the cosigner.
Having a cosigner is essentially like an insurance for the lender because by signing the document, the cosigner is agreeing to pay the loan in case the borrower fails to do so. The cosigner is equally responsible for the loan even if they’re not the one responsible for the EMI payments.
Now that we know what cosigning a loan means, let us see what important questions to ask before cosigning a loan:
“Why would someone ask me to cosign a loan in the first place?”
Someone would ask you to cosign a loan in the first place when they can’t get credit on their own. This can be due to various reasons, including their bad credit score, past loan default, or missed EMIs. However, this can also be because someone, like your children, are new to credit, and they have never taken a loan or credit card before. The lack of credit history for a new to credit person will make it very difficult for them to get a loan, which is why they need you to cosign their loan application.
“How does cosigning a loan affect my credit score?”
Cosigning a loan essentially means that you are as responsible for the loan as the borrower. If the borrower is late on his EMI payments, it will affect your credit score. If the borrower defaults on the loan, it will fall upon you to repay the loan, and if you can’t then your credit score will be severely affected. Cosigning a loan is a big responsibility, especially when you consider the effect it can have on your credit score.
On your credit report, it will also add to your debt. This will affect your debt-to-income ratio, and adding more debt can bring down your credit score by itself. However, what is also to consider that if the loan is paid back in time, without any missed payment, it will add positively to your credit score.
Remember: It is important to keep an eye on your credit score, especially if you have cosigned a loan. You should check your free credit report online every few months and ensure that everything stays on track.
What are the cons of cosigning a loan?
Here are a few downsides of cosigning a loan that you should keep in mind:
- If the borrower of the loan fails to repay then you are completely responsible for paying off the remaining balance of the loan.
- If the borrower defaults on the loan, then your credit will drop as though you were the one who defaulted.
- In case of a default, if the lender decides to file a suit for the loan, they are likely to first sue the cosigner because of their higher credit score.
- You can not take your name off the loan agreement after the loan has been approved. You are on the hook until the loan is entirely paid off.
- It can destroy your credit rating if the borrower delays the EMI payments, or defaults on the loan.
“How to be safe when cosigning a loan?”
You can’t ever be fully safe when cosigning a loan. However, you can take certain precautions and mitigate your risk:
- Know the borrower really well, and make sure this is someone you can trust with such a huge responsibility.
- Review your budget and be prepared to make the payments in case the primary borrower fails to do so. You will have to pay the loan back by yourself to save your credit history from being destroyed.
- Make sure you get copies of everything. And here we are not just talking about copies of the loan agreement. But also request to have duplicate statements sent to you or obtain login credentials so you both always know the status of debt payments.
Thus, make sure you know what you’re getting into. The decision to help out someone to get a Personal Loan or any other loan, should not be taken lightly. This is a decision that will affect your life positively or negatively.
Which is why it is always a great idea to take the necessary steps to ensure that you safeguard not only your credit scores but also your own finances.
