Understanding what it means to co-sign on a loan
Before anyone cosigns on a loan they need to understand the what it means to be a co-signer as well as the benefits and the risks.
What does it mean to cosign on a loan
Many people think there is a difference to being a primary borrower and a cosigner. However, the differences are slim. Cosigning on a loan means that you are agreeing to pay a debt if the primary borrower cannot make the payments. For example, if the primary borrower fails to make even the first payment on a financed vehicle that you cosign, you are agreeing to make that payment and all other payments that the primary borrower fails to make. You essentially are the borrower. The main difference is that you are borrowing the money without the rewards of that money. For example, if you co-sign on a car, you are borrowing money to pay for the car, but you do not get to enjoy the car. You are essentially agreeing to be responsible for the debt without receiving anything in return.
Benefits of Cosigning
You are helping someone in need
Cosigning on a loan gives you the opportunity to help someone. This could be a parent cosigning on their child’s student loan. Or helping a family member purchase a vehicle. It can be rewarding to help the friends and family members in your life, especially if they do not have the credit to obtain the financing. It can help them rebuild their credit, while achieving their goals.
Cosigning on a loan might help build the credit of both signers on the loan. For example, many parents will have their children as a cosigner while they are at an early age or cosign on a credit card for the child. This can help them learn to use credit and build their credit score at an early age. For people that have poor credit, having a cosigner will allow them to finance a loan or a vehicle and rebuild their credit.
Disadvantages of Cosigning
Responsible for the debt
You are responsible for the debt. Although the primary borrower is also responsible for the debt, so is the cosigner. As stated above, being a cosigner is nearly the same thing as being the borrower. If a payment is not made by the primary borrower, the cosigner is expected to pick up the slack and make the payment. As a cosigner, the debt also belongs to you even if you did not receive any money from the loan, or the car does not belong to you.
Debt to income ratio
Cosigning on a debt will increase your debt to income ratio. The loan will show up on your credit report. For example, if you cosign on your child’s home, the mortgage will show up on your credit report as your debt. This also means that you may have a difficult time financing a home should you decide to purchase on after you have cosigned on the home. Or, if you cosign on a student loan, you might have a difficult time getting a credit card or a loan for your own wants or needs whatever it may be.
Hurt your credit score
As stated above, by cosigning on a loan, you are getting into more debt. When you get into debt, your credit score might drop. If you credit score goes down, you will have a harder time borrowing money for your expenses, trips, home etc.
If the primary borrower files for bankruptcy, you will be the only one left that is liable for the loan. You will not be able to recover or sue the primary borrower for any payments you have to make on the cosigned loan. This is true for student loans, mortgages, cars and credit cards etc. Therefore, if you cosign for the primary borrowers financed car and they default on the payments, you will be responsible for paying the car. To make matters worse, if the car is repossessed and auctioned off you will be responsible for the deficiency. Even worse, if the primary borrower files bankruptcy, you will be the sole person liable for that deficiency. You will also never be able to legally recover any money you might have paid from that primary borrower.
Therefore, if you are thinking about cosigning on the vehicle you must really weigh the pros and cons and understand the contract you are getting into. While we all take out credit cards, finance vehicles and borrow from banks, we normally get the benefit even if we default on our own loans. However, when you are a cosigner, paying back a loan that you did not receive the benefit for is a difficult thing to do.