Dubai: There’s more to standing guarantee or co-signing a loan than just lending your signature. Before you help a family member or a loved one, make sure you understand the impact co-signing a loan can have on your finances and credit score.
When you stand guarantee or co-sign on a loan or credit card application, you formally take on legal responsibility for the account, which means any debt and payments will appear on your credit report. But let’s briefly walk through what exactly co-signing entails.
When you co-sign a loan, you are guaranteeing to pay off somebody else's debt if the borrower stops making payments for any reason. The most significant reason a co-signer is involved when taking a loan is that a co-signer helps a borrower get approved by adding their name to the application.
In addition to being responsible for repaying the loan, if the borrower cannot or does not repay, a co-signer may also have to repay interest amounts that get accumulated, any late fees that may have piled up, or charges incurred by any debt collection agency – if they have been assigned to collect dues.
Types of co-signed loans
There are a few important differences in the types of loans that might be co-signed, including mortgages, student loans, auto loans and personal loans.
If you co-sign an auto loan, it doesn’t give you any rights to the car. But you are responsible for the loan if the borrower fails to keep up with payments.
Similarly, co-signing a mortgage loan doesn’t give you the rights to the house as an occupant, and co-signing for a personal loan doesn’t allow the money to go to you, but you will be responsible for repaying the loan in both cases.
Key perks and risks of involving a co-signer when borrowing money
Co-signers are necessary when the borrower is unable to qualify for a loan on their own. There are different reasons this might happen, such as not enough income to cover loan payments, poor credit, any history of bankruptcy or absence of a history of borrowing money.
Co-signers typically have enough income and sufficient credit scores to strengthen the loan application. With the co-signer involved, lenders may decide to approve an application.
While those are the key advantages of being a co-signer – what are the risks?
Co-signing a loan makes you liable to pay for the entire balance should the primary borrower fail to pay. Keep in mind that most lenders are not interested in having you pay half of the loan either. This means that you’ll have to work it out with the primary borrowing party or eventually pay off the entire balance.
You might co-sign on a loan for a car you’re not driving or a mortgage for a house you don’t live in, but that doesn’t change your liability if the primary borrower fails to make payments. Your credit score benefits only slightly from the monthly payments.
If you co-sign a loan, you’ll want to keep tabs on monthly payments, even if you trust the person you co-signed for. If you wait to get a call from a due collection agent informing you of missed payments, your credit will already have been negatively impacted.
Even though a loan you co-sign is not in your name, it shows up on your credit report, since it’s debt that you are legally obligated to pay. So when you go to apply for another loan in your own name, you might find yourself denied for an application because of how much credit you have in your name.
What are the rights and responsibilities of a co-signer or one standing guarantee?
Being a co-signer doesn’t give you rights to the property, car or other security that the loan is paying for. You’re simply a financial guarantor, and if the primary signer fails to repay the debt, then you’re next in line to make it happen.
Credit history, credit score, income, debts, employment and other financial details are all likely to be considered as part of the loan application when you agree to become a co-signer for someone.
Banking analysts are of the opinion that a lender will look for a co-signer to strengthen the credit profile of an application, generally because the borrower doesn’t qualify on their own. Because of this, you’ll likely have to go through a stringent credit check when the primary borrower submits their application.
It’s important to understand that serving as a co-signer can ultimately hurt your own credit score if the borrower makes payments late, since any actions on the loan are tied to both the primary borrower’s and your credit reports.
On the other hand, being a co-signer can also help improve your credit score if the borrower is someone who is responsible about consistently making payments on time.
Also, if the primary signer on the loan stops making payments or falls behind, you can request a ‘co-signer release’. This is a form that the primary borrower will need to sign off on releasing you from the obligations of the loan.
In addition, the lender also must approve the removal of the co-signer (which it will only do if the primary borrower can demonstrate that they have the credit and history to handle the payments).
If I do plan to co-sign, what all should I consider?
If you’ve been asked to co-sign on someone’s loan, although your good credit could help a friend or loved one achieve their financial goals, you need to consider whether it is fiscally good for you. Here are a few things to consider before signing:
Type of loan you’re co-signing for: Secured loans are riskier for borrowers because there’s collateral on the line — a house, car or another piece of property. Any added risk for the primary borrower is added risk for the co-signer, too.
Risk against your high-credit status: Lenders may want to see co-signers with high credit scores, a long history of consistent, on-time payments; steady employment and verifiable income. But if this does this apply to your finances, the question is if you are willing to risk your high-credit status to co-sign the loan.
Long-term rewards of being a co-signer: If you’re co-signing a loan to help your child go to college or build up credit early on, then the risk may be worth it in the long run.
Financial planners view that if you’re simply helping a friend pay off credit card debt or buy a car that’s outside of their price range, it’s probably not the best move — for you or for them.
Is co-signing different depending on the type of loan?
The process of co-signing may look different from lender to lender, but the responsibility of a co-signer, regardless of the loan type, will typically remain the same: to make the payments if the primary borrower fails to do so.
Co-signer release, on the other hand, can look slightly different based on the type of the loan.
For example, some mortgage loans require the primary borrower to refinance in order to release a co-signer from the loan, while others, like education loans, have set rules for when the primary borrower may take full responsibility for the loan.
How to protect yourself when co-signing a loan?
The first way to protect yourself as a co-signer is to be aware of what you’re signing up for. Speak to the primary borrower and ask them about their income and how they plan on making the monthly payments.
This also involves thoroughly reviewing the loan and its terms so you know exactly what you’re liable for if the primary borrower is unable to make the payments on time. The best way, experts add to initially protect yourself is to be as informed as possible.
After you know what the loan terms are, establish a plan with the primary borrower that involves a monthly check-in when the payments are due. This not only will create a level of accountability, but also will keep you in the loop as to what you may be responsible for paying.
Lastly, before signing, establish a timeline that will allow the borrower to raise their credit score or gain some financial history without leaving you potentially responsible for payments for a prolonged period of time.
If I decide not to co-sign for a personal loan, what are the alternatives?
Before a borrower asks someone to co-sign a loan, here are some ways to determine if this is the only way to get financial assistance:
First, what you should do in case you don’t want to co-sign for a friend or family member’s personal loan, is look for an alternative type of loan. The borrower could choose a cheaper option.
Like for example, when possible, buy a cheaper car instead of one that requires a large loan, or, if the borrower needs money for education-related-expenses, he or she can take out a student loan that won’t require a co-signer.
Sometimes a gift or loan from a friend or family member is an easier – and less stressful – way to obtain or avoid a loan. For example, a larger down payment on a home or car purchase could help someone get loan approval on their own.
Some lenders will accept collateral in exchange for your loan. If you’re comfortable with the risk, think about putting down your home or vehicle as collateral. Remember that if you can’t pay off your loan, you will lose your collateral, which can put you in serious financial trouble.
Note: Even though borrowers really want a loan, they need to make sure they absolutely need it. The risks a co-signer needs to take are considerable. Borrowers might not need help securing a loan if they wait another year or two and build up their credit record.