A sibling, friend or child with a weak credit rating, or little credit history, might ask you to cosign a loan for a home, a car, college tuition or another important expense. Cosigners can help friends and family members make the desired purchase and improve their credit scores, assuming the borrowers make timely payments to the lender.
It’s important to consider the ramifications of that signature before saying yes, however. Cosigning isn’t a mere vote of confidence in the borrower. If you agree to cosign, you’re promising to make good on the loan should your friend or family member fail to pay.
What are cosigners responsible for?
In short, a cosigner takes responsibility for repaying the loan, the U.S. Consumer Financial Protection Bureau (CFPB) notes. If the borrower misses a payment or fails to repay the entire debt – no matter what personal promises they made to the cosigner – the cosigner generally is legally obligated to pay.
As the Federal Trade Commission puts it, by backing the debt, you’re being asked to take on financial risk for someone else when a financial institution won’t. Not only might you have to shoulder any unpaid debt, you could be saddled with late fees as well, the FTC notes.
The lender will detail the arrangement and potential consequences for non-payment in a cosigner’s notice, which establishes, among other specifics, that the lender can collect the debt directly from the cosigner.
If a loan goes into default, a lender could take legal action against you or garnish your wages or bank account. Defaulting on a federal student loan could result in garnishment of tax refunds and Social Security payments.
If the borrower defaults on the loan and you fail to pay, your own credit score may suffer. In fact, as credit reporting agency Experian notes on its blog, lenders aren’t obligated to notify you if the borrower is late on a payment, so you could find your credit score knocked down because of an unknown late payment.
Experian recommends arranging for online access to the loan account so you can make sure payments are current, and the CFPB suggests asking the lender to send you monthly statements. The FTC suggests that, before cosigning, you ask the lender to agree to alert you if your friend or family member misses a payment.
The FTC also suggests you bear in mind that if you secure the cosigned loan with collateral, you might lose that property in case of default. Even if the borrower dutifully pays on time, the loan will count as part of your own debt, which could affect your ability to get new credit for your own purposes.
You might be able to negotiate with the lender to limit your responsibility to the principal only, according to the FTC.
What to do if the person you cosigned for doesn’t pay?
If the borrower you cosigned for stops paying and is unwilling or unable to catch up, you’re likely on the hook for the loan. You might see if the lender will work with you to modify or suspend payment arrangements but they may not be under any obligation to do so.
You also could explore refinancing if it will help you lower payments or, better yet, convince the borrower to refinance and place the debt in his or her name alone.
In extreme circumstances, if you’ve taken on more debt by cosigning than you can afford, you might have to seek bankruptcy protection; remember, however, that a cosigned federal student loan is unlikely to be dismissed in a bankruptcy proceeding.
Depending on the loan and its terms, you may be able to be removed as a cosigner after a certain stretch of timely payments. Ask the lender what options may be available for release from the loan.
How can I get out of being a cosigner?
The easiest way to get out of being a cosigner is to avoid becoming one in the first place. Before agreeing to cosign a friend or family member’s loan, consider your own financial health and whether you’d be able to easily cover the debt should the borrower fail to pay.
If you do cosign, take care before doing so to protect yourself. The Federal Deposit Insurance Corp. recommends that you ask the lender in advance about release provisions, and that you ask the borrower how he or she plans to repay the debt.
Experts also suggest you talk seriously with the person making the request so they understand the risk to your own credit and finances.
Consider alternatives to becoming a cosigner, such as becoming a loan guarantor, which would make you responsible only after the lender has tried all other steps to collect from the borrower.
If you do go forward as a cosigner, do it with eyes open and plans in place to protect your own finances.