As generous as cosigning a loan for someone is you need to know that it comes with a great deal of risk. While on the one hand, you will be helping a family member or even friend to qualify for a loan that they would have missed otherwise, on the other hand, you will be putting yourself and your credit rating at great risk should they default. Before you even consider cosigning a loan for someone, you need to know:
- That YOU can pay should they default.
- That YOU have an excellent credit rating that actually adds value to the transaction.
- That YOU can trust the borrower to honour the agreement.
- That the borrower is actually good for the money and that they need it for something worthwhile.
As much as knowing all this may not save you should the borrower default, it is often best to cover all your bases before going into any financial transaction. This gives you a clear picture of the situation and may even highlight alternatives to cosigning.
What does it really mean to cosign a loan?
Technically, as a cosigner you will be helping the actual borrower get approved for a loan. Say for example your son/daughter or close friend needs a £200,000 loan but they only qualify for £120,000. By attaching your superior credit score to the transaction and promising to act as a back-up borrower and payer, you can increase their borrowing power to twice that amount or even more. The cosigned loan amount might even come to £300,000 depending on your credit score.
Once you agree to cosign, you become 100% accountable and responsible for the loan payments as well. Should the borrower default, the banks will come after you for the monthly payments until the loan is complete as well as any late payment penalties accrued. Before you cosign any loans, makes sure that the terms are favourable and you can handle the payments should the worst happen.
Risks associated with cosigning a loan
There are quite a vast number of risks associated with cosigning a loan. These risks include:
- Damage to your credit score: Should the borrower default in any way, this will show up in both the borrower’s as well as your credit reports.
- It might leave you cash strapped: If they default it is up to you to pay the monthly fees.
- You could face legal action: Lenders are at liberty to take legal action against both of you.
- Reduced ability to borrow: With a ruined credit score, your ability to borrow will be greatly diminished.
- You are in for the long haul: Once you have entered this kind of agreements, lenders will not let you leave until the loan is fully repaid.
As you can see, these risks as considerable. There are, however, alternatives to cosigning a loan if you do not have the stomach for the risks. You could do any of the following instead:
- Help with the down payment.
- Give them the money they need.
If you do, however, decide to cosign with someone. You need to:
- Be in constant communication with them.
- Keep current on the payment progress.
- Manage the risks by always looking at the statements and staving off any potential late payments.
- Try to get released from the contract at a certain point.
Cosigning a loan for someone is an excellent and generous gesture but it is best to go into it with your eyes wide open.Tags: cosign a home loan, how to cosign a loan, what you need to know before cosigning a loan