TomorrowMakers

Co-signing is a way to help your friends, family, or relatives secure a low-interest loan for which they can't qualify themselves due to low credit score or high debt to equity ratio. Learn more in detail.

Co-signing a Loan Pros and Cons

If you have a good credit score and have kept the debt to income ratio low, then you might have surely got some requests from your friends or family or anyone from the relatives to become a co-signer and help them secure a much-needed loan.

I am sure that you won't have denied them as they genuinely needed your help, and it was just a sign through which their chances to secure a loan might be highly increased. So in the entire scenario, did you end up helping them and ruining your credit score, or things went smoothly? 

Before you make a firm call, you need to understand the fact that co-signing isn't just about you doing a sign for the primary borrower and helping him/her out in odd times, but it is also about the consequences and the risk factors which you will face as a co-signer.

Don't worry; you will get to know each and everything in this article, and rest assured that after reading this article, you will be in a better position to make the best possible decision regarding going ahead with co-signing or not.   

Also Read: Step by step guide to building a strong credit score

1. What does it mean to co-sign?

A primary borrower whose credit history isn't much great, has many ups and downs, or has a high debt to income ratio may find it very difficult to secure a loan. This is when the role of a co-signer comes up, and due to his/her credibility and a high credit score, the chances of the primary borrower securing a loan increase significantly.

Also Read: Personal loan or a credit card loan? Which one should you opt for and when? 

Thus a co-signer can be anyone who has these two things:

  • High credit score
  • Low debt to income ratio  

You must also be aware that as a co-signer, you are responsible for paying up the debt or loan taken up by the borrower. Thus, you are legally liable for the same, and many things are at stake for you as a co-signer, and if things go wrong, you may end up ruining your personal finance, credit score, and savings.

At this point, it is also essential to understand the difference between co-signing and co-borrowing. Because both the concepts are different, but they are often assumed to be the same.

The major difference between both of them is:

  • In co-borrowing, the co-borrower gets the right over the property, asset or money which is part of the loan. Whereas in co-signing, the co-signer doesn't get any ownership over the property, asset or the money for which the loan was taken.

There is also a similarity between co-signing and co-borrowing, which is as follows:

  • In both co-borrowing and co-signing, the co-borrower and co-signer are responsible for paying up the loan or remaining dues and penalties if the borrower isn't able to pay them due to their incapabilities.

Also Read: Getting a home loan? Know these home loan charges before you apply?

2. When co-signing is a good idea?

Co-signing a loan doesn't give you the right over the property, asset or money for which the loan was taken, but there are some rewards that you will enjoy as a co-signer like:

A. You will get self-satisfaction 

Helping others during unstable situations is the best gift you can give them, whether they want a loan for their first home, first car, or they are a student who needs a student loan. You should be happy and proud to see that they will get a better future with the help you provided them. Thus self-satisfaction and the smile and happiness on the faces of others is your reward here.

B. Your credit score will increase

Your credit score will increase as the EMIs paid on time; you being the co-signer, the loan and its payments are reflected in your credit history. Although if you already have a good credit score, it might not drastically increase, you can still expect a small rise in your credit score. 

Also Read: Taking charge of your credit score

3. When is co-signing just a flat out bad idea?

It is rightly said that every coin has two sides, and the same is the case with co-signing because there may be some repercussions if things don't work out as per the plans.

The banks or creditors may run behind you in this case, and then you will become responsible for paying up the dues, penalties and other fees they might levy. Along with this, there will be many consequences which you may need to pass through like:

A. You will face limited credit flexibility: 

If you have co-signed for a massive loan which might be a home loan, personal loan, or anything else, you won't be able to apply for a new big loan anytime soon. The main reason here is that this big loan will be shown in your credit history as borrowing, which will become a possible hurdle if you need a loan for yourself.

Along with this, your debt to income ratio will also skyrocket as now you have a big loan reflected in your credit history.

B. You will be responsible for paying dues:

This is one of the worst-case scenarios you might have to pass through if the things or plans of the borrower who was paying the loan EMIs somehow fail or he/she declares bankruptcy. In this case, you may face a court notice, and creditors may force you to pay the remaining dues plus levy some hefty penalties and fees, which will end up on your shoulder.

In addition to that, if you had kept anything as security or even a mortgage like your car or some precious jewellery. Then the banks and creditors can pawn them to get their money back since you as a co-signer are legally responsible for clearing all the dues.

C. You will lose your credit:

If even a couple of payments are missed, then your credit history may get a big hit, and your credit score may start falling, which will directly impact your future capabilities to get a loan at cheaper rates.

D. Your relationship with the borrower will get a hit:

When the borrower cannot pay EMIs or sticks the entire loan to you, then the difficult conversations about money or even violent fights in the worst-case scenarios may end your relationship no matter if the borrower is your relative or friend, or a close family member. And in this entire situation, you may end up losing one of your best friends or a close relative.

E. Removing yourself from the loan as a co-signer is very difficult:

As seen in the above cases, if things go wrong, then it is tough to remove yourself as a co-signer from the loan. One way out can be refinancing the loan, but it is also not that easy because if still, the primary borrower isn't eligible to get a loan by themself, then this option won't work.

Summary

  •  As a co-signer, your credit score will also increase if the primary borrower pays all the EMIs on time and clears the loan.
  • You, as a co-signer, also get a chance to save someone's future or life and help him/her start a new bright future with the loan, which is currently much needed for them.
  • As a co-signer, you are the legally liable person to pay up all the dues if the primary borrower becomes incapable of doing so.
  • Whenever things come about mixing finances and relationships, there are high chances that they may end up due to mismanagement.