The Responsibilities and Risks of Cosigning on a Loan
A lender requires a borrower to have a cosigner on a loan when that borrower has no credit history or a poor credit score. The loan itself could be for a home, a car, or for college expenses. Some personal loans can also be taken out with the help of a cosigner. Undoubtedly, this can be a huge help to a young college student who doesn’t have a credit report yet or a friend who’s getting back on their feet, but it can also put the cosigner in hot water if a loan payment is missed.
Cosigners reduce the risk of the debt of a loan for a lender because the cosigner is contractually obligated to repay the debt if the borrower fails to make one or more payments. The cosigner becomes a form of collateral, essentially. And while a cosigner is equally responsible for the loan with the borrower, they do not hold an ownership interest in any property purchased with the loan, such as a house or a car.
Before you offer to cosign on a loan for a family member or a friend, read the following responsibilities and risks you’d be taking on.
A cosigner guarantees the loan will be repaid on time and in full, but this is more than simply vouching for a friend or acting as a character witness. While the ideal scenario has the borrower making all loan payments, legally the cosigner assumes ultimate responsibility for the loan regardless of the borrower’s actions. The full payment of the loan may include late fees or collection costs incurred. If a cosigner pledges any assets as collateral—like a car or jewelry—the lender can require them as payment if any terms of the loan are breached by the borrower.
There are usually only two ways for a cosigner to be released from their responsibilities: the borrower pays the loan in full or, for student loans, a certain percentage or amount of the loan is paid. If the borrower dies, the cosigner may still be on the hook to pay the loan. The lender may try to receive payment for the remaining balance from the borrower’s estate, but they can also choose to go directly to the cosigner for payment.
A Cosigner takes on a larger amount of risk than the borrower—after all, with a good credit report, better cash flow, and more valuable assets, they have the most to lose.
Because a cosigner is equally responsible for the repayment of the loan, that debt will appear on the cosigner’s credit history. It follows that whatever the borrower’s repayment habits—good or bad—will also be reflected on the cosigner’s credit history and score for seven years. If the borrower defaults, the cosigner’s credit will suffer. Even if the borrower makes all on-time payments, having the loan on the cosigner’s credit report will affect their debt-to-income ratio, which may negatively affect their own applications for loans or credit cards.
If the loan becomes a collections account, the collections agency can use the following collection methods against the cosigner: demanding full loan repayment, a lawsuit for payment, or garnished wages or banking accounts. In some states, the lender can collect the debt from the cosigner without first trying to collect payment from the borrower.
If you decide to cosign on a loan, make sure you can pay it back in full if you have to. Ask the lender to agree, in writing, to notify you if the borrower misses a payment or the terms of the loan change. Carefully read the cosigner’s notice, given to you by the lender, which outlines your obligations. Also check the state laws regarding cosigner rights.