Is It A Good Idea To Co-Sign A Loan?

Bob Musinski has written about a variety of financial-related topics – including personal and business loans, credit cards and personal credit – for publications such as U.S. News and World Report. He has worked as an editor and reporter for multiple publications and an international wire service. You can follow him on twitter (@bobmusing)

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Rachel WitkowskiCorrespondent/Editor

Rachel Witkowski is an award-winning journalist whose 20-year career spans a wide range of topics in finance, government regulation and congressional reporting. Ms. Witkowski has spent the last decade in Washington, D.C., reporting for publications including The Wall Street Journal, American Banker and Bankrate. Ms. Witkowski's deep knowledge of government and policy aided a series of investigative stories that triggered congressional hearings on employee claims of discrimination at a federal agency and how indirect auto lenders were being reviewed by regulators.

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Updated: Mar 29, 2021, 4:26am

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If you co-sign a loan for a friend or family member, you could help that person buy a house or car, obtain much-needed cash or secure enough money to attend college. But if the co-sign arrangement doesn’t work out, you could severely damage your credit as well as your relationship with the borrower.

Here is a guide to what co-signers and borrowers need to consider before entering into a co-signing arrangement:

What Does it Mean to Co-Sign?

When a primary borrower’s negative credit history or high debt load prevent them from securing a loan on their own, a co-signer helps assure lenders that the loan will be paid. The co-signer—who usually has a much stronger credit history and lower debt-to-income ratio than the borrower—is providing a guarantee the debt will be paid.

For example, it would be difficult for someone a couple of years out of high school with not much of a credit history and a low-paying job to buy a home without a co-signer. Co-signers can also assist people who have a long but spotty credit history and a high debt load that makes them more of a risk.

Co-signers also help prospective borrowers get a much lower interest rate on a loan than they could on their own.

An ideal co-signer will likely have:

A credit score of about 670 or higher, which is considered “good” by the two primary credit score analysts—FICO and VantageScore
A debt-to-income ratio that is under 43% for a mortgage, and possibly higher for other loans

The Difference Between Co-Signing and Co-Borrowing

A co-borrower is different from a co-signer because the co-borrower has a right to the property or money that is part of the loan, whether it’s an auto, home or personal loan. In contrast, a co-signer does not get any rights to the property covered by the loan.

For example, spouses often co-borrow on mortgage loans, and business owners might go in together on a personal loan that helps their business. As with co-signing, both parties are responsible to pay back the loan, but the property obtained by co-borrowing—such as a car driven by both spouses—is likely used by both.

Risks of Co-Signing

By guaranteeing a loan for someone you’re taking on considerable risk. If the borrower doesn’t make the payments, you’re ultimately responsible for the loan—even if you don’t live in the house or drive the car.

If you co-sign a loan, you could:

Have limited credit flexibility. A new loan in the credit history—especially a large one like a mortgage—could drive up your debt-to-income ratio high enough to make it impossible to take out another large loan.
Develop credit problems. If you miss a couple payments, it will negatively affect your credit history and score, as would collection actions. When you deal with a collection agency, you could face penalties and fees, and your wages could be garnished.
Be forced to pay back the loan. You could be required to pay back the loan if the borrower dies, declares bankruptcy or defaults and the lender forces payment in a lawsuit. The creditor might also be allowed to approach you for payment before the borrower.
Lose a relationship. Difficult conversations about money can complicate even the strongest relationship, especially if the borrower decides not to make payments and sticks you with the loan.

Benefits of Co-Signing

Because co-signers don’t have any right to a loan’s underlying property—but are exposed to all the risk of non-repayment—co-signing on a loan can be risky. However, there are some benefits.

First, giving someone you know a chance for a new start—whether it’s a first-time homebuyer or a person recovering from a rough financial patch—is the most rewarding part of co-signing. For example, you might co-sign a mortgage loan for a child who hasn’t had a chance to build an extensive credit history but is financially reliable, helping them take advantage of historically low interest rates.

Second, a borrower who has little to no credit history or who is recovering from debt collection situations or even bankruptcy can use a co-signed loan as an opportunity to make payments on time and build a stronger credit record. This is particularly beneficial because payment history can strongly influence the credit score calculation for FICO and VantageScore.

A co-signer’s credit score might eventually see an increase if the loan is effectively paid off, but likely not much if the credit record was strong already.

When Does Co-Signing Make Sense?

If you end up co-signing a loan, here are some steps you can take before signing on the dotted line:

Be part of the conversation. Whether it’s a mortgage, auto loan or student loan, you should discuss the arrangements with the lender and borrower to understand the obligations of each party once the loan is signed. For example, what happens if you pledge property to back the loan and the borrower defaults on the loan? You also should review co-signers’ rights as granted by the state in which the loan is issued.
Review paperwork. It’s important for you to see—and potentially influence—all contracts related to the loan, including the co-signer release conditions. If there is a breakdown in communication between you and the borrower, it’s important for you to have the documents to deal with disputes.
Create a plan. You and the borrower need to figure out how to communicate about the loan. For example, the borrower could notify you if a payment might be missed; you could have online access to the account; and the borrower ought to provide a heads-up if the property will be sold or the loan refinanced.

Getting a Co-Sign Release

The most direct way for you to get out of a co-signed loan arrangement is to make sure that right is in the contract, along with the terms under which you can do so. For example, a co-signer of a private student loan could be released from obligation after a designated number of payments—such as 12 months, in the case of Sallie Mae loans.

Other options to get released from the loan include:

Refinancing. If borrowers refinance the loan on their own, the loan you co-signed will be paid off and you will be released of your obligations.
Paying off the loan. Once the borrower pays off the loan, your financial ties are gone.
Selling the property. If the borrower sells the house or car being financed, the loan will be paid off. However, you won’t have a choice in this—it’s up to the borrower to sell.

Types of Co-Signed Loans

There are a few important differences in the types of loans that might be co-signed, including mortgages, student loans, auto loans and personal loans.

If you co-sign an auto loan, it doesn’t give you any rights to the car. But you are responsible for the loan if the borrower fails to keep up with payments. Similarly, co-signing a mortgage loan doesn’t give you the rights to the house as an occupant, and co-signing for a personal loan doesn’t allow the money to go to you, but you will be responsible for repaying the loan in both cases.

Alternatively, a co-signer is not needed for many student loans—federal student loans as well as some private student loans do not require it.

Alternatives To Co-Signing

Before a borrower asks someone to co-sign a loan, here are some ways to determine if this is the only way to get financial assistance:

Try an alternative loan. Secure a mortgage loan tailored to first-time homebuyers or borrowers with a mixed credit record.
Choose a cheaper option. When possible, buy a cheaper car instead of one that requires a large loan.
Take out a student loan. If the borrower needs money for education-related-expenses, he can take out a student loan that won’t require a co-signer.
Ask for a loan or gift. Sometimes a gift or loan from a friend or family member is an easier—and less stressful—way to obtain or avoid a loan. For example, a larger down payment on a home or car purchase could help someone get loan approval on their own.
Wait. Even though borrowers really want a loan, they need to make sure they absolutely need it. The risks a co-signer needs to take are considerable. Borrowers might not need help securing a loan if they wait another year or two and build up their credit record.