If you are trying to make a large purchase, such as a car, and have limited credit history or past credit problems, you may not qualify for a loan — meaning a co-signer might be an option.
Simply put, a co-signer is a person who agrees to be legally responsible to pay a debt if the borrower does not pay back a loan as agreed. One common scenario is for parents to co-sign on an auto or student loan for young adults who are establishing a credit history.
What to know when you co-sign
“If you’re looking for a co-signer, it’s best to select someone you’re close to – a family member or trusted friend,” says Sharla Godbehere, vertical leader of online financial services at Equifax. “You should feel comfortable explaining your financial situation, and discussing your finance plans with them.”
Some things to keep in mind if you ask someone to co-sign on a loan:
— Know who you’re entering into the agreement with. Be sure your co-signer is someone with whom you’re willing to be honest with about your credit history and any past problems you may have had.
— Realize the agreement may not be forever, depending on the lender. Some lenders will allow a co-signer to be released from their loan obligations after you’ve made a certain amount of on-time payments, and if your credit and financial history has improved enough that you are able to qualify for and be responsible for the loan on your own.
— Because you, and the person you have asked to co-sign, will be responsible for the loan payments, as with any loan, it’s a good idea for both of you examine your budgets and make sure you will be able to make the loan payments for the length of the loan.
What to know if you’re asked to co-sign
If you are asked to co-sign a loan for someone, remember that “you are responsible for that debt” if it isn’t paid as agreed, Godbehere said. If the lender reports to any of the three major credit bureaus, the loan will be reflected on credit reports issued by those bureaus, and may impact credit scores if payments aren’t made on time.
“I would want to understand the person’s financial situation,” Godbehere said. “Why are they asking you to co-sign? What is their source for paying back this debt? Is there going to be a potential challenge?”
It may also be important to understand why a co-signer is needed – whether it’s because a person is trying to build a credit history, or whether they have credit problems. If it’s the latter, “that’s a big red flag,” she said.
Have a frank discussion with the person about their plans for repayment, she said. “Do they have a steady job? Do they have a source of income? What is the loan for?”
Come up with a plan ahead of time for how the two of you will cooperate to make sure timely payments are made on the loan, she suggested.
Some other things to keep in mind if you agree to co-sign on a loan:
— Make sure the person who initiated the loan can repay it – and make sure you would be able to in the event they default on the loan. If you can’t, this may impact credit scores or even lead to wage garnishment or legal action against you.
— There are some cases where you may be able to negotiate with the lender specific terms of your co-signing financial obligation — for instance, being able to limit your liability to only the principal amount on the loan, not including late charges, court costs or attorney’s fees in the event of default. Be sure the lender or creditor includes a statement in the contract reflecting these terms before you co-sign.
— You can ask the lender or creditor to notify you in writing if the borrower misses a payment or if the loan terms change.
— In some states, creditors may be able to collect the debt from you without first trying to collect from the borrower. Find out whether that’s the case in your state.
While being a co-signer can be an option to help someone establish a credit history, it’s not without risk. Before you ask someone or agree to co-sign on a loan, make sure you understand all the pros and cons.
The information contained in this blog post is designed to generally educate and inform visitors to the Equifax Finance Blog. The blog posts do not give, and should not be assumed to provide, personalized tax, investment, real estate, legal, retirement, credit, personal financial, or other professional advice. Before making any financial decision, you should always consult with the appropriate professionals who can explain your options, rights, and legal responsibilities, and advise you on any tax, legal, credit, or business implications that may result from those decisions. The views and opinions expressed by the authors of blog posts are their own views and may not be the views or opinions of Equifax, Inc. and/or its affiliates.