What Is a Cosigner and How Do Cosigner Loans Work?

Let’s say your friend or family member applies for a loan. It may be a car loan, mortgage, or personal loan. No matter the loan type, they may not qualify independently if their credit history has issues. They may ask you to help them out by being a co-signer.

Before becoming a cosigner or asking someone to be one, ensure you’ve read this blog to fully understand what a cosigner is, its implications, and all the potential risks and responsibilities involved. So, let’s dive in!

KEY TAKEAWAYS

• A cosigner is someone who guarantees a loan for a borrower. They agree to take on the responsibility of the debt and repay the loan if the primary borrower fails to do so.
• When the borrower doesn’t have a strong credit history or income, a cosigner is necessary to get the loan alone.
• Applying for a loan with a cosigner helps secure the loan and negotiate better terms.
• The loan appears on both the primary borrower’s and the cosigner’s credit reports.
• The borrower’s payment behavior will impact the cosigner’s credit score and ability to get loans in the future.

How Do Cosigner Loans Work?

Cosigner loans add a safety net for the lender to protect against defaults.

Having a cosigner for a car loan or any other type of loan gives the lender confidence that the loan will be repaid if the borrower misses a payment or defaults, especially if the borrower has a less-than-ideal credit score and history.

The borrower benefits from the cosigner’s strong credit profile, which increases the chances of loan approval and may qualify them for better loan terms.

Who Is a Cosigner?

A cosigner is someone legally responsible for your loan. This means the cosigner is expected to pay on your behalf when you fail to make a payment on time. Essentially, this person is the backup safety net for your lender to ensure that the loan will be repaid even if you don’t.

To become a cosigner, the person must meet specific requirements such as a high credit score (690 or above), stable financial standing, low debt, and a long history of consistent on-time payments. This could be one of your parents, siblings, close friends, or even a partner willing to back up your loan.

Responsibilities of a Cosigner

Understanding what it means to be a cosigner also means recognizing that being one comes with a great responsibility. It’s not just signing your name on a dotted line; it’s a serious financial commitment. 

Here’s what co-signing a loan means:

• The cosigner is legally obligated to repay the loan if the borrower can’t make the payments; this includes the principal, interest, and any late fees.
• The loan will appear on the cosigner’s credit report just like the borrower’s. Any late or missed payments will negatively impact both credit scores.
• If the borrower defaults and the cosigner fails to cover the payments, the lender can take legal action against the cosigner.

Loan Application Process

Applying for a loan with a cosigner isn’t all that different from applying for any other loan.

1 During the application, You and your cosigner must provide personal information, including your SSN, employment details, and financial history.

2. The lender will run a credit check on both of you to assess your creditworthiness. The cosigner’s good credit helps offset any concerns about the borrower’s credit history.
3. If the lender is satisfied with the combined creditworthiness, they may approve the loan.
4. After approval, both parties must sign the loan agreement and are responsible for repaying the debt.

Does Being a Cosigner Affect Your Ability to Get a Loan?

The total amount is added to your credit report when you co-sign a loan. While lenders can tell that you are a co-signer on the loan, it still affects your debt-to-income (DTI) ratio, one of the leading indicators of your creditworthiness.

Co-signing a loan increases your total debt, raising your ratio and making you less eligible for more loans until the co-signed loan is paid. 

So, when you want to apply for a credit loan, mortgage, or car loan, lenders will consider that you’re already responsible for a significant amount (even if it’s not technically yours) and may be less willing to extend any more credit.

Advantages and Disadvantages of Cosigner Loans

As you’ve noticed, co-signing a loan has its ups and downs, both for the borrower and the cosigner. Let’s weigh the pros and cons so you can assess your options carefully.

Advantages

As the cosigner, you have only one benefit from participating in the loan process — helping your friend or family member receive a loan. You won’t see a boost in your credit score or any other tangible benefits. 

On the other hand, there are drawbacks to consider.

Disadvantages

The most lasting and impactful disadvantages of cosigner loans are the risks we sometimes overlook before agreeing to co-sign, which are:

• If the payments aren’t made on time, this will negatively affect the credit scores of both the borrower and the cosigner.
• The cosigner is responsible for settling the payments if the borrower fails to do so.
• Money and relationships can be a very tricky mix. Initially, the impact of your co-signing the loan can be very positive and even strengthen your ties with your long-lost relative. However, when financial situations change, the same tie might become a suffocating burden.
• Co-signing a loan can limit your eligibility to apply for future loans.

FAQ

Let’s address some of the most frequently asked questions about what a co-signer is.

What Is the Correct Definition of a Cosigner for a Loan?

A cosigner has a solid financial profile and agrees to repay a loan if the primary borrower defaults. They sign the loan agreement alongside the borrower, become equally responsible for the debt, and are legally obligated to repay it if the borrower cannot.

Why Would a Borrower Get a Cosigner for a Loan?

When applying for a loan, in some cases, the applicant might need a cosigner. Typically, this happens when the applicant has:

• Poor credit (FICO score below 580)
• No credit
• Low income
• High debt-to-income ratio
• Unstable employment history
• Large loan amount

Does Co-signing a Loan Build Credit?

No, co-signing a loan does not help build or improve the cosigner’s credit. If payments are made on time and the creditor reports to one of the credit bureaus, then the borrower may be able to build credit, not the cosigner.

What Benefits Do You Receive by Taking Out a Loan With a Cosigner?

The primary benefits of taking out a loan with a cosigner include an improved chance of loan approval, a better interest rate, access to more significant loan amounts, and building and improving credit.

Can I Be Removed as a Cosigner from a Loan?

Sometimes, a cosigner can be removed from a loan through cosigner release. This typically requires the primary borrower to demonstrate good payment behavior, such as making a set number of on-time payments and proving that they can handle the loan independently. Not all loans offer cosigner release, so checking the loan agreement is essential.

Please note that a cosigner release is not always available.

What Happens if the Primary Borrower Defaults?

If the primary borrower defaults or stops making payments, the lender will turn to the cosigner to cover the costs. Suppose the cosigner also cannot make any payments. In that case, the lender can take legal action against the cosigner, leading to severe consequences, including suing the cosigner for the remaining balance, garnishing their wages, or placing a lien on their properties.