Risks and Benefits of Co-Signing a Loan - Rest Nova Site

Risks and Benefits of Co-Signing a Loan

Risks and Benefits of Co-Signing a Loan

Say a good friend or family member wants to buy a home but doesn’t have the credit to pull it off. You, on the other hand, have an excellent credit report. So, you feel badly for the person and agree to co-sign a mortgage. There’s no skin off your back you figure since co-signing costs nothing, and the person has a good job.

But is doing so a sound decision on your part?

Here are the risks and benefits of co-signing a loan – and more.

What is a Co-Signer?

Along with the primary borrower, a co-signer assumes full responsibility for repaying a loan and any fees, should the borrower be unable to pay. For the primary borrower, having a co-signer on their loan provides the lender with extra assurance that the loan will be repaid, or gives them a better rate.

Note that even though the co-signer must repay the loan if the borrower does not, the co-signer has no right to loan funds.

Who Usually Needs a Co-Signer?

A person needs a co-signer if they either cannot qualify for a loan or their own or can’t get one with a good rate. That’s usually because they have a credit score that’s on the lower end or what the industry calls a “thin” file — one that has few to no accounts listed.

That’s not to say that a person can’t get a home equity more with bad credit – they can. If you’re interested, learn more.

Are There Benefits to Co-Signing a Loan?

We’ve mentioned some of the major risks to co-signing, and we’ll go into that more shortly. But you may be surprised to learn that there are also benefits as well, beyond the satisfaction of knowing that you helped someone get a loan and possibly build their credit.

The main benefits of co-signing have to do with credit. If the borrower makes consistent, on-time payments, that will boost your credit history. Also, if co-signing improves your credit mix, you may get a modest benefit. It’s always good to have installment loans along with revolving accounts such as credit cards.

Now, about those risks.

 What are Risks Involved with Co-Signing a Loan?

The fact is that you are financially vulnerable if you co-sign a loan. Here’s how:

  • You are on the hook for the whole loan amount. That’s the main risk, plus any fees. Prior to agreeing to co-sign, evaluate your financial situation to be certain you can handle loan payments in case the chief borrower can’t.
  • You could hurt your credit score. Co-signing a loan means that both the loan and payment history appear on your credit report – not just the borrower’s. if the borrower misses a payment, your credit score will be affected. Also, your score will take a temporary hit since the lender must do a hard pull on your credit before approving the loan.
  • You may be turned down for credit. A potential creditor may see the co-sign situation and decide that it renders your credit application too risky.
  • The lender could sue you. Depending on the state involved, the lender may attempt to get repayment from you first if the borrower doesn’t make payments. Lenders typically mull legal action when the debt is a minimum of 90 days past due.
  • The relationship with the borrower could be hurt. Good intentions notwithstanding, circumstances can change and affect the borrower’s ability to make full, on-time payments. If the borrower defaults, your relationship with that person has a good chance of souring.
  • It’s difficult to remove co-signer status. It can be done, but the process isn’t straightforward. For instance, you can refinance the loan to get yourself removed, but that’s only if the primary borrower is now independently eligible for a new loan.

In summary, yes, there are risks and benefits when it comes to co-signing a loan. However, as honorable as it is to help someone out, inherent risks are significant, as you can see. If you do decide to co-sign, just be sure you have the wherewithal to cover the loan in case the borrower can’t.