Getting A Personal Loan With A Cosigner
Each person has their own rules and philosophies about lending money to loved ones. For some, it's a minefield destined for avoidance at all costs. For others, money lent to friends or family members is essentially a gift, with repayment not expected but nice if they can manage it.
What if someone you know is asking you to lend your credit instead of your money? In general, the same principles apply. The risks, however, can often be much bigger.
Whether you’re the loan applicant or the person considering cosigning a personal loan, here are some things you'll need to understand before you agree and sign on the dotted line. Please note that Rocket Loans does not currently offer cosigned loans.
What Is A Cosigned Personal Loan?
You can use personal loans for a variety of large purchases. However, not all lenders allow cosigners. A borrower may use apersonal loan for home improvement projects or repairs, debt consolidation or unexpected costs that they can't cover out-of-pocket.
A cosigned personal loan is a way for people who cannot qualify for a loan on their own, due to poor credit or poor financial standing, to obtain the funding by adding someone else’s credit score and income to their application. In some cases, adding a qualified cosigner to a loan application can help you receive a higher loan amount and lower interest rates.
How Does Getting A Personal Loan With A Cosigner Work?
When you get a personal loan with a cosigner, both parties are on the hook for the entire duration of the loan. That loan is legally the cosigner’s just as much as it is for the primary borrower.
This means that cosigned loans, and all the activity associated with them, including payment history, will also show up on the cosigner’s credit report. If you cosign a borrower’s loan and the borrower misses loan payments, the lender will turn to you to make them. If you don't, your credit score will take a hit.
The cosigner is typically responsible for a cosigned loan until it's paid off. In some cases, you may be able to apply for a cosigner release, which will allow you to remove your name from the loan if the primary borrower meets certain requirements, such as having made a specific number of on-time payments and meeting the lender's credit standards.
Cosigner releases are common with private student loans, but you may have this option on other types of loans. Talk to the lender or read your loan documents to find out if you have this option as a cosigner before signing any loan agreements.
Another way to get your name off a loan before it's paid off is if the borrower refinances into a new loan in their name only. This requires the borrower to have the credit history and income to be able to qualify for a loan on their own.
What Does It Mean To Be A Cosigner?
When you cosign a loan, you become legally responsible for the repayment of that loan. As the cosigner, you also agree to repay the loan if the primary borrower doesn't.
It can be difficult for someone with bad credit to get a personal loan without a cosigner. Having a person with good credit cosign the loan can help these borrowers get approved, even if they don't meet the creditor's requirements on their own.
While acting as a cosigner can help those who are in need of credit but can't get it, it also comes with a lot of risks for the cosigner, and very little reward.
Things To Consider Before Cosigning A Personal Loan
If you’re considering cosigning a personal loan to help a loved one, you should be fully prepared to make every single payment on the loan until it's completely paid off. If your finances can't handle that or you simply don't want to take on that responsibility, you shouldn't cosign the loan. The loan is legally yours, too, and you should treat it as such when deciding whether you can afford to take it on.
Keeping that in mind, here are some additional things you should think about if you're deciding whether to sign or not.
Know Your Rights
It's important that you understand what your rights are as a cosigner on a loan. Federal law requires lenders to provide you with a cosigner's notice listing what your obligations are as the cosigner. Here's what that notice will say, according to the Federal Trade Commission:
● You're being asked to guarantee this debt. Think carefully before you do. If the borrower does not pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility.
● You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount.
● The creditor can collect this debt from you without first trying to collect from the borrower. The creditor can use the same collection methods against you that can be used against the borrower, including suing you or garnishing your wages. If this debt is ever in default, that fact may become a part of your credit record.
● This notice is not the contract that makes you liable for the debt. It’s important to note that the official loan documents are what makes the cosigner legally liable for the personal loan, not the cosigner’s notice listing.
Your state may provide more extensive protections for cosigners. For example, state law may require lenders first attempt to collect payments from the primary borrower before collecting from the cosigner. Or, your state may mandate that lenders inform cosigners when a loan has become delinquent. Make sure you know what your state's laws are and what kind of protection you can (and can't) expect.
Understand The Contract
You may be able to have certain protections included in your contract as well. Take the time to read all the relevant loan documents and make sure you know what agreements you are making with the lender.
Pay attention to whether or not the lender will notify you of late payments. If this isn't included in the contract, ask for it to be included in writing. That way, you won't be in the dark if things start to go south on the loan.
According to the FTC, you may be able to negotiate some of your liability with the lender. For example, you may ask if it's possible for you to only be liable for the principal balance. That way you'll only be responsible for the loan itself, and not any late fees or legal costs the borrower may incur.
Finally, get your own copies of all the important loan documents.
Consider Your Debt-To-Income Ratio
One often overlooked aspect of cosigning a loan is how it can affect your own finances even if everything goes according to plan.
Remember that when you cosign a loan, creditors view that loan as belonging to you. This impacts your debt-to-income ratio, or the portion of your income that’s spent on debt payments.
If the cosigned loan pushes your DTI too high, you may have difficulty getting approved for your own loan, even if the primary borrower has made every single loan payment on time.
If you're considering getting a mortgage in the near future, you'll want to keep your DTI below 50%. If cosigning a loan pushes your DTI past this point, you may want to reconsider.
If you're going to cosign a loan for someone, you'll need to have an open and frank conversation about their finances, your own finances and if they're able to handle the monthly payments.
It can be an awkward discussion, but having a better idea of their financial situation can help you keep tabs and better evaluate your risk. For example, do they have a savings account for emergencies that could cover their monthly payments if necessary, or will they expect you to back them up if they have a budget emergency?
You should also consider asking the borrower for access to the loan account, including getting log-in credentials if the loan information is available online. That way you can check in each month to make sure the loan is still current and payments are still being made in full and on time.
The Pros And Cons Of Cosigned Personal Loans
Now that you understand how cosigned personal loans work, let’s review the benefits and drawbacks of getting one.
The Pros Of Cosigned Personal Loans
- The borrower builds credit. It’s no secret that the borrower primarily benefits from obtaining a loan with the help of a cosigner. By making on-time payments to a personal loan, the borrower will build credit and increase their credit score over time.
- The borrower qualifies for lower interest rates. By applying for a loan with a cosigner, the borrower will most likely receive a lower interest rate than they would have if they applied on their own. This benefits both parties because the total cost of repaying the loan will be lower, and more attainable for the borrower.
- The borrower may get a higher loan amount. Similar to qualifying for lower interest rates, the borrower is likely to receive a higher loan amount with the help of a cosigner.
The Cons Of Cosigned Personal Loans
- The borrower and cosigner risk their relationship. Unfortunately, not every example of a cosigned personal loan is a success story. If the borrower is unable to make the loan payments, meaning the responsibility falls onto the cosigner, the pair risks damaging their relationship. That’s why it’s important for both parties to communicate their financial standings and responsibilities prior to signing the loan documents.
- Any missed payments would lower both credit scores. If the borrower misses loan payments or stops paying altogether, both parties’ credit scores will be affected. This could seriously affect the financial future of both the borrower and the cosigner, as well as everyone’s ability to qualify for new loans.
- The debt limits the borrowing power of both parties. Since lenders examine your debt-to-income ratio in order to approve new lines of funding, the personal loan debt could tie up your borrowing power. For the borrower, the appearance of a cosigned personal loan on your credit report could be viewed as risky for other lenders.
How Do I Apply For A Personal Loan With A Cosigner?
If you’re ready to apply for a personal loan with the help of a trusted cosigner, the first step is to find a lender that allows you to add their information to your application. Not all traditional lenders allow cosigners, but there are several online lenders that grant personal loans with cosigners.
Once you’ve narrowed down your options, shop around to various lenders to find the best loan terms and interest rate. That way, both parties can feel confident that they’re getting the most favorable deal possible.
To get a personal loan, the borrower and the cosigner will be required to submit their personal and financial information. Both parties can expect to submit the following documentation to the loan lender:
- Current address
- Pay stubs
- Bank account information
- Tax forms
- Social Security number
- Bank statements
While cosigning a loan can be a generous way to help a loved one build credit, there are a lot of risks involved.
Life is unpredictable, and even those who have the best of intentions could end up in a situation where they simply cannot pay. Be sure that both the borrower and the cosigner are ready to take on the financial responsibility of the personal loan.
For more personal loan tips, check out our Learning Center.
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