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The 411 on Co-Signing a Loan

Sooner or later, someone you know may ask you to co-sign a loan for them. When someone asks you to co-sign, it usually means they can’t get approved for a loan individually.

The reasons can range from insufficient income to a credit history that doesn’t meet the lender’s minimum qualifications. However, sometimes it’s because the would-be borrower doesn’t have a credit history.

Regardless of the reason, you need to know how co-signing a loan could impact you and your credit.

The Loan Shows Up on Your Credit Report

When you co-sign for a loan, it appears on your credit report. However, the lender also pulls your credit history during the approval process. This means you’ll have an inquiry on your report, and the payment history will also show up.

Essentially, it’s like the loan is yours. You’re financially responsible for repaying it even though the other person is doing that. For example, say you co-sign on an auto loan for your son or daughter, and your child defaults on the loan.

The lender will also try to recoup payments from you. In this situation, you need to take over the payments to avoid more blemishes on your record. If payments aren’t made, the lender could pursue legal action against both of you.

But on the bright side, good payment history from the person you co-signed for benefits your credit score. So, although you aren’t the one paying the loan back, you can keep your credit score high or improve it. That is if you don’t overextend yourself with other loans.

Your Debt-to-Income Ratio is Impacted

Future creditors don’t distinguish between loans you took out for yourself and ones you co-signed for. In other words, they see the amount on a co-signed loan as something you borrowed. Therefore, if the loan still has a balance, it impacts your debt-to-income ratio.

So, if you want to take out a mortgage, a co-signed loan’s outstanding balance is figured into the lender’s decision. Most mortgage lenders have debt-to-income cutoffs. So, while a small, co-signed loan might not seem like a big deal, it could be down the road.

Say you make $50,000 a year and have a car loan with an outstanding balance of $20,000. You also have a few credit cards you use occasionally. Your combined credit limits are near $10k, and most months, you have a balance of $1,000.

However, you co-signed on a loan three years ago that has a remaining balance of $20,000. For a lender, your debt-to-income ratio is too high. As a result, you will likely get a thumbs down on your application, delaying your home buying plans.

Removing Your Name from a Loan Can Be Difficult

Once you’ve co-signed for a loan, it can be challenging to remove your name from it. Usually, the person you’ve co-signed for must refinance the loan in their name. And they may not have a sufficient credit history or income to do this for years.

Co-signing on student loans and credit cards can also leave your name attached for years or decades. That is until the main borrower has made enough payments on time for the co-signer to be taken off the loan.

But even if you eventually remove yourself from the loan and its financial obligations, you’ll still be tied to the original loan. That will remain on your credit report indefinitely. So, it’s best to limit who you co-sign for and ensure they’re responsible for their money and credit.

Be Sure to Ask for Account Access

After you co-sign on a loan, it may be tempting to trust the person to make on-time payments and forget about it. However, this can be a recipe for trouble. Go ahead and ask for access to the loan account. Many let more than one borrower set up separate online logins.

This way, you can keep yourself in the loop. You’ll see if payments are being made on time, the outstanding balance, and any changes. For instance, the primary borrower might make a lump sum payment to reduce the balance.

This works in your favor, especially if you need to apply for a loan for your own needs. In addition, maintaining online account access lets you know when the loan’s paid off. Knowing these things helps with your financial planning.

You Don’t Have to Co-Sign

Say someone asks you to co-sign on a loan. While you might feel guilty or hesitant about saying no, it’s your right to do so. If you don’t want to be on the line for another loan or line of credit, explain your perspective to your friend or family member. They should understand.

There are also alternatives to asking someone to co-sign. That person could go to a lender with less stringent requirements. Some creditors help people who don't have much credit history or who have bad credit build or rebuild their credit.

People who can’t get approved for conventional loans can also ask banks for secured loans. A secured loan is when collateral is tied to the loan as a guarantee. For example, if the borrower can’t make payments or defaults, the collateral is possessed and sold by the lender to pay off the balance.

If a family member asks you to co-sign on a loan, consider lending them the money outright. You can both sign a notarized agreement that spells out a repayment plan. This is a good choice if you have enough money saved up or in the bank.

Final Thoughts

Co-signing for a loan is never an easy decision. To begin, you’ve got to consider the reliability of the person asking and how co-signing will impact you financially.

Remember that the loan’s payment history and balance will go on your credit report if the loan’s paid on time; co-signing can benefit you in the long run.  

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