What is a co-signer?
A co-signer is someone who adds their name, credit profile and financial information to the primary borrower’s loan application. When you co-sign a personal loan, you agree to be legally responsible for repaying the full loan and any additional fees should the borrower be unable to pay.
People usually need a co-signer because they can’t qualify for the loan by themselves. If you have a strong financial profile, co-signing for someone with a lower credit score or thin credit profile can help them qualify for a loan or snag a lower interest rate.
A co-signed loan is different from a joint loan, where two borrowers have equal access to the loan. As a co-signer, you have no right to the money even though you could be on the hook for repayment.
Risks of co-signing a loan
You may be asked to co-sign a personal loan for your spouse, child or friend, especially if your credit score outshines theirs.
But what sounds honorable — helping someone get money for debt consolidation or an emergency expense — can have consequences you may not expect.
Financial risks of co-signing a loan
1. You're responsible for the entire loan amount
The biggest risk of co-signing is that you’re promising to repay the borrower’s loan, including late fees or collection costs, if they’re unable to do so.
Before you co-sign, make sure you can cover the loan payments in case the primary borrower cannot.
2. Your credit is on the line
The lender’s hard credit check during the loan approval process will temporarily lower your credit score by a few points.
More importantly, when you co-sign a loan, both the loan and payment history show up on your credit reports, as well as the borrower’s. A missed payment by the borrower can negatively affect your credit score. Since payment history has the biggest influence on credit scores, a misstep can wreck your credit.
3. Your access to credit may be affected
The long-term risk of co-signing a loan is that you may be rejected for credit when you want it.
Your debt-to-income ratio — the percentage of your monthly income that goes toward existing debts — is a major factor on many credit applications. A potential creditor will factor in the co-signed loan to calculate your total debt levels and may decide it’s too risky to extend you more credit.
Legal risks of co-signing
4. You could be sued by the lender
In some states, if the lender does not receive payments, it can try collecting money from the co-signer before going after the primary borrower, according to the Federal Trade Commission.
By that point, the borrower would likely have missed several payments, and the debt would already have hurt your credit. Lenders are likely to consider legal action when the debt is at least 90 days past due.
If you are sued for nonpayment and the creditor wins a judgment, you’ll likely be responsible for all costs, including attorney’s fees.
5. Removing yourself as a co-signer isn’t easy
If issues arise, you may not be able to remove yourself as the co-signer.
Many lenders don’t allow a co-signer release. Those that do may require a credit check of the main borrower to ensure they can make the payments on their own. Personal loans typically require a certain number of on-time payments before the lender will reassess the primary borrower to see if they can make payments on their own.
Personal risks of co-signing
6. Your relationship could be damaged
The borrower may start out making full, on-time payments toward the loan with good intentions. But financial and personal situations change.
If the borrower falls behind on payments, your credit score can drop and lenders might go after you for payment. The negative impact on your finances can create friction between you and the borrower.
Benefits of co-signing a loan
Co-signing a loan for someone can help them qualify for a personal loan or other financial product they could not get on their own, or save them interest with a lower rate.
When someone has a thin credit history or is rebuilding their credit, having a co-signer with a good score and an established credit history is powerful.
Lenders that allow co-signers
Most lenders don’t allow personal loan co-signers; joint loans are far more common. However, these lenders may allow you to co-sign a personal loan on behalf of a family member or friend:
» MORE: Compare the best personal loans
Does co-signing a loan build credit?
Here’s how being a co-signer can build your credit:
It adds to your payment history, as long as payments are made on time. However, if you have a high score and well-established credit, the effect may be small compared with the danger to your score if the borrower doesn't pay.
It might improve your credit mix, which could give your credit score a small boost. It's useful to have both installment loans (with fixed payments) and revolving accounts (like credit cards).
Here’s how the person you co-signed for can build their credit:
It can help them qualify for credit they otherwise would not get, boosting a thin credit file.
They can build positive payment history by making on-time payments on the account.
How to protect your credit if you co-sign a loan
You can safeguard your credit if you co-sign a loan by taking a few proactive steps:
Verify that the main borrower can afford payments: Ask the primary borrower to make a budget that shows their income and expenses. They can use a personal loan calculator to estimate their monthly loan payment. Avoid co-signing if the payment doesn’t fit comfortably in their budget.
Consider whether the payment fits in your budget: If you’re thinking of co-signing, make sure you can afford the worst-case scenario that you’ll need to take over payments. You could also ask the lender for the final loan payoff amount.
Request direct communication from the lender: Ask the lender to send you monthly statements so you can confirm that the primary borrower is up-to-date on payments. You can also ask the lender to contact you directly if they miss a payment so you can take action before it hurts your credit.
Stay in contact with the borrower: Make sure the borrower understands that you’re putting your credit on the line. Let them know that they need to contact you immediately if they can’t afford a payment. You can also ask the borrower for access to the loan account so you can keep tabs on when payments are made.
Alternatives to co-signing a loan
If you want to help out the borrower without risking your credit, you could lend them money directly through a family loan (or a similar agreement if you’re not related).
A family loan doesn’t involve a third-party lender, so there’s no formal application or approval process. Instead, get a notarized, written agreement between you and the borrower summarizing terms.
Family loans can help borrowers get cheaper loans and avoid predatory lenders, but they still put your finances at risk if the borrower is unable to repay the loan.
If you don’t want to co-sign or give them a loan directly, they may have other options:
Secured loan: A borrower might be able to offer items like their car or a savings account as collateral on a loan. This is known as a secured personal loan and comes with its own risk. If the borrower is unable to make payments on the loan, the lender will take the pledged asset.
» COMPARE: Best secured personal loans
Credit union loan: A credit union loan may be an option for borrowers with fair or bad credit (score of 689 or less). Credit unions consider your history as a member when you apply, making it easier to qualify with less-than-perfect credit. Federally chartered credit unions cap APRs at 18%,
Bad-credit loan: Some online lenders work specifically with applicants who have bad credit. These lenders have looser borrowing requirements than banks and may evaluate other factors, like education and where you work, in addition to your credit score. However, bad-credit borrowers are typically offered the highest annual percentage rates, typically above 25%.
» COMPARE: Best loans for bad credit
