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Getting a Personal Loan With a Cosigner
Cosigning a personal loan has its advantages and disadvantages.
On the upside, a borrower who partners with a trusted cosigner with good credit (usually a friend or family member) can obtain a personal loan, and start building some good credit, too, with regular on-time payments.
On the downside, if the personal loan borrower falls behinds on payments, or defaults on the loan altogether, the cosigner is on the hook for the full remaining loan balance, and must take over the payments.
That scenario can have negative repercussions for both the borrower and the co-signer. When a personal loan lags or defaults due to no payments, the borrower and the co-signer risk seeing their credit rating slashed and personal financial situation is threatened.
That’s a scenario that occurs all too often.
According to a report from Princeton Survey Research International Associates, 38% of U.S. co-signers said they had to repay at least part of the loan. Also, 28% said they suffered a decline in their credit scores.
Why Would a Personal Loan Borrower Need a Co-Signer?
While different lenders may have different underwriting methods, most look at the same general qualifications when vetting a personal loan. That process could result in the borrower’s application for a personal loan denied. Here are the most common reasons borrowers need cosigners, according to James Walsh, CEO at BillionsIntheBank, a finance and investment training platform.
Credit health. If your credit history isn’t great, you may not be able to qualify for a loan on your own, regardless of your other qualifications. “Or. you may be able to qualify for a loan, but with a high interest rate and outrageous fees,” Walsh said. “A cosigner can essentially loan you their credit score in order to boost your chances of approval.”
Income. For most loans, your income needs to justify the loan. For example, if you earn $30,000 per year, you’ll probably find it difficult to borrow $70,000 to buy a new Lexus. “However, if a cosigner is willing to use their own income for consideration, a lender may be willing to give you the loan,” Walsh said.
Employment. Lenders generally want to see a steady employment history, and this is especially true with long- term loans like mortgages. “For example, a lender might want to see that you’ve worked in the same field for at least two years without any breaks,” Walsh added.
Debts. “Even if your income and credit are strong, if you have a ton of other debts, lenders may reject your application. “A cosigner can use their own debt-to-income ratio to justify the loan,” Walsh said.
The Inside Scoop for Both Parties in a Co-Signing Situation
Before either party – the borrower and the co-signer – agree to team up on a personal loan, both need to understand the obligations undertaken.
Here are the main factors to consider for the borrower.
Be honest, when you ask a co-signer to help out. A borrower should approach their family or friend honestly.
“The borrower should tell the potential co-signer the nature and amount of the loan, and how they intend to use it for a better future,” said Luke Smith, founder of We Buy Property in Kentucky, a real estate investment company. “It’s best to have all the answers to the questions before you ask, that way you can lay all the facts out for your cosigner. Doing this in a quiet, safe space is a good idea.”
Put the agreement in writing. If the cosigner agrees to partner up on the personal loan, then both parties should put the agreement in writing. “It’s best to know the expectations from both parties, along with consequences should one party not fulfill their end of the agreement,” Smith said.
Have a plan for tough financial situations. If the borrower falls behind on payments, just like anything in life, it is a negotiable scenario.
“It’s best to communicate with your cosigner and let them know what is going on and why you are unable to service your part of the loan,” Smith said. “However, based on the aforementioned agreement, you may forfeit your stake in the asset or be required to remunerate your cosigner along with any penalties or fees for late payments.”
Treat it as a business deal. Personal loan co-signing situations come with abundant risk, and the borrower needs to recognize that.
“Most of the time: your family loves and cares for you and does not want to see you in a bad financial situation,” said Justin Nabity, a certified financial planner at Omaha, Neb.-based Physicians Thrive. “If possible, a trusted friend or family member would do whatever they can to help you by loaning you the money or through the co- signing of a personal loan.”
“However, this isn’t as simple as taking the money,” he added. “ It is not a gift. It is a loan after all and you will need to pay that loan back. Over time these loans can be risky as they have the ability to put a strain on family relationships if the money isn’t paid back promptly.”
Here are the main factors for the co-signer
Study your own financial situation. Before you co-sign a loan for a family member, determine if you are able to afford the monthly payments on your own.” If the person you are signing a loan for suddenly loses their job or can’t pay the monthly payments, you become responsible for making the payments,” said Ryan Luke, a personal finance blogger at Arrest Your Debt, a household money management web site. “If you can’t afford the monthly payments in a worst-case scenario, both parties will default on the loan.”
Protect your own loan experience. Don’t co-sign a loan if you are going to need an additional personal loan in the near future. “Co-signing is the same as taking a loan out on your own and goes against your credit,” Luke
said. “If you’re in the market for a new home, the loan you co-signed will count against you during any future loan application processes until it’s paid in full.”
Know the score. Co-signers’ credit scores are also impacted when they sign on to help a family member or friend. “According to Experian, the initial issuance of the loan can negatively affect your credit just like late payments or defaults,” Luke said.
Also, if the primary borrower is unable to make payments, the co-signer is responsible for the loan. “If
you’re unable to make the payment in full, you can be sued by the loan company and your wages may be
garnished,” he added.
The Takeaway on Co-Signing a Personal Loan
Even though most co-signers feel like they are doing the right thing, often they are enabling bad financial behavior by co-signing a loan.
“A co-signer must understanding the true reason a friend or family member needs a loan is important before making any decisions,” Luke said. “ If they routinely overspend and default on loans, co-signing a personal loan is only going to make the situation worse.”
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Brian O'Connell has been a finance writer at TheStreet, TheBalance, LendingTree, CBS, CNBC, WSJ, US News and others, where he shares his expertise in personal finance, credit and debt. A published author and former trader, his byline has appeared in dozens of top-tier national publications.