There are many questions that you may have when presented with the decision of cosigning on a loan with someone. Statistics show that 40% of people who cosign on a loan will end up paying part of, or the entire payment. Of course, while there are some risks to consider when cosigning a loan, there are some positive reasons to be aware of as well. So with that in mind, what are those questions you need to consider when cosigning a loan?
Why are you being asked to cosign on this loan?
There could be multiple reasons. Perhaps the lender has stated that their income, relative to the new payment they are seeking, is too low and they need a cosigner’s income to supplement that. If that’s the case, you need to make sure you both have a clear understanding of how the signer plans on consistently making this payment.
It could also be that their credit score is simply too low. If that is the case, how much do you personally know about their credit history? Contrary to popular belief, you can’t tell how well a person pays their bills simply by looking at them. If a bank is wary about lending this person money, you might need to be wary as well. Of course, if you know more personal information about why their credit score isn’t up to snuff and it can be justified, you can provide something to this person that the bank will not -- empathy.How long are you on the hook for?
Short answer: The entire duration of the loan. There is no such thing as only cosigning for a year or two and taking yourself off the loan. The only way for that to be possible is for the original signer to refinance that loan in their name only, or to pay off the total and complete balance. Those are the only two options. So if you’re signing your name on a loan for 72 months, make the assumption that you will be responsible for that loan for an entire 72 months. Which brings us to….How could the cosigned loan affect me?
For the entire duration of that loan, the balance and monthly payment will be totaled in your credit score. Not half of the balance, not half of the payment. All of it. So take that into consideration when you’re thinking of cosigning. That loan will be included in your debt to income ratios and will likely be considered when looking at your total monthly car payments, relative to your income. It may not be too difficult for you to cosign on this loan, and get a second auto loan. But if you’re in need of a second car loan yourself, that situation can be more difficult when you already have two in your name - though not impossible. So be sure you think about what your own financial needs might be for years down the road. Certainly, you want to make sure those payments are being made on time because….This WILL affect your credit score (for better or worse).
If before you cosign on a loan you are told that it won’t have any effect on your credit score, you’ve just been lied to. Whether you sign first or second, it affects you just the same. If one payment is missed, that blemish will be recorded on your credit report just the same as you missing the payment. If so many payments are missed that the loan has to be sent to collections, all of that negative history goes on your credit report. Will you be able to ensure that each payment is made every month? Are you willing to pay it if the other signer doesn’t? If all payments are made on time, it could certainly benefit you just as well. In fact….There are sensible reasons you may want to cosign on a loan.
Ever hear the saying, “It takes money to make money”? Well, one could also say “It takes credit to get credit”. So, what does someone who’s just starting out in life do when they haven’t had a credit history to speak of? Unfortunately for many the answer is to pay a significantly higher interest rate if they can get financing at all. Is that really the best way to have Junior start out on his road to life? If you have a high-school or college grad looking to get their first car, it may make a lot of sense to help cosign on their loan to help get them started in the right direction. Generally speaking, if a 700 credit score cosigns on a loan with someone who is a 600 credit score - or even a no score as young Junior most likely is, you’ll end up with an interest rate that a 700 score qualifies for. Doing it this way will help Junior keep his first car payment low and have most of the payment go towards the principal. Junior will also begin building their credit history and have a credit score that they can soon be proud of. In only a few months (8-16), Junior could quite possibly refinance that loan into their name only and get a very respectable interest rate. That means your name will come off the loan completely, and Junior maintains a great interest rate. Financing young buyers, and even refinancing that loan down the road is a specialty of PayLowRate.com and the experts there can help walk you through both situations. Cosigning a loan is an important decision. But sometimes it can be a rewarding opportunity as well.