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(From the Financial Literacy Blog) – Within the U.S. financial system, credit is the ability to borrow money to access goods or services with the understanding that the borrower will pay the money back later. Credit unions, banks, and other lenders issue credit to people who want to obtain something, but either can’t or don’t want to pay for it now. Before someone is granted any credit, lenders determine the borrower’s creditworthiness, or how likely they are to pay the money back in full and on time. Creditworthiness is represented by a credit score, which is a number between 300 and 850. The higher the score, the better one’s creditworthiness.
When someone has a poor credit score, they may have trouble obtaining a loan. If they are granted credit, they may be faced with a higher interest rate—meaning they’ll pay a larger charge for the privilege of borrowing the money. In order to be approved for a loan or to receive more favorable interest rates, a hopeful borrower can seek out a co-signer.
What Is a Co-Signer?
A co-signer is a person who agrees to take responsibility for a loan with another person—often because the primary borrower wouldn’t qualify for a loan on their own, or because they only qualified for a loan with a high interest rate. Essentially, a co-signer is someone who promises to repay the debt if the primary borrower fails to do so. Despite the legal responsibility of repaying the loan if payments aren’t made by the other person, a co-signer has no rights to the loan funds or any assets funded by the loan. A co-signer usually takes on the risk in order to help someone they care about, such as a friend or family member.
What Are the Pros and Cons of Being a Co-Signer?
Pros:
Helping Someone in Need
Oftentimes, the main benefit for a co-signer is that they’re helping someone they care about. By putting their credit on the line, they can help a friend of family member secure credit they might not otherwise qualify for. Co-signing can help younger borrowers get a start in life or help someone re-establish their credit after they went through a difficult time. Co-signing can make it possible for someone to finally purchase their first home, get a vehicle so they can drive to work, or even refinance existing debt at a more affordable rate.
Possible Increase of Credit Score
If the primary borrower is making their payments in full and on time, it can positively impact the credit of the co-signer. The loan can also improve the co-signer’s credit mix, which can also lead to higher credit scores.
Cons:
Possible Decrease of Credit Score
Missed or late payments, collections, and repossessions can negatively impact the co-signer’s credit score. Even though they are the benefactor of the original loan, they are still on the hook to ensure it gets paid back. The co-signer should be in regular contact with the primary borrower—that way they can come up with a plan if payments can’t be made on time.
Strained Relationship
If the co-signer needs to take over the loan payments or they have their credit impacted by missed payments, their relationship with the primary borrower could become strained. Even if payments are being made, having to monitor one’s own financial obligations, along with someone else’s, can become exhausting and stressful.
Limited Control
A co-signer typically has no control over the account. They may not receive statements or updates on the loan’s status unless the borrower shares this information.
The Bottom Line:
At the end of the day, a co-signer can help friends and loved ones secure credit they wouldn’t be able to on their own. However, the co-signer is taking on equal financial liability. It’s important for them to weigh the strength of their relationship with the primary borrower and to consider all of the pros and cons before signing anything.