Asked to co-sign? What to know before co-signing a mortgage or loan
Author: Maria Smith
Have you ever been asked to co-sign for a loan or mortgage for a close friend or family member? If so, did you agree to sign the dotted line? There are many situations in which co-signing may be an option. It could be for a young person without any credit history or someone more experienced with unsuitable credit. If you're trying to decide whether to cosign, here are some things to be aware of.
What is a co-signer?
A co-signer is someone who can help a candidate qualify for a loan or mortgage when they aren't eligible on their own.
Having a co-signer reduces the lender's risk as there is now more than one person responsible for ensuring repayment of the loan. With a co-signer, the loan has a backup, someone who will pay if the primary borrower doesn't. Lenders like co-signers and are more likely to lend with them.
Parents may choose to act as co-signer for their children to help them qualify for a mortgage. Or, you may decide to co-sign for a friend or family member who has a poor credit score.
Co-signers and primary borrowers are equally responsible for paying back the loan.
Mortgage co-signer vs. guarantor
Although similar, a mortgage co-signer and guarantor are slightly different.
A co-signer will have their name on the title, sign all the paperwork, and boost a weak applicant. A lender will consider both the co-signer and primary borrower's incomes and credit histories when determining the loan terms.
Loan guarantors are less common. And although they guarantee repayment of the loan, they are not on the title and are often not required to sign all of the mortgage paperwork.
Co-signer vs. co-borrower
Both a co-signer and co-borrower are liable for repayment of the loan. Their incomes and credit histories, along with those of the primary borrower, will be considered when determining the loan terms.
A co-borrower can receive the proceeds of the loan, and they possess ownership rights to the object of the loan. Often a primary borrower and co-borrower have joint ownership of the item in question. An example of this is two people buying a home together.
On the other hand, a co-signer has no ownership rights to the loan's item, even though they will be on the title.
What to know before co-signing a loan or mortgage
Deciding to co-sign a loan is an important decision and not one to be taken lightly. Here are nine things you should know before you co-sign a loan or mortgage.
Impact on your credit
When you decide to co-sign for something, the lender considers your credit score and history.
The lender will do a hard pull of your credit which in the short term can negatively affect your score.
In the long term, because you are responsible for the loan, it will also impact your score. Depending on your credit history, this impact could be minimal or could substantially decrease your credit score.
Obligation to pay
You're legally obligated to repay the loan should the primary borrower default on their payments. One would hope that this never happens. But as a co-signer, you need to be prepared for the worst-case scenario. Are you able to make the loan payments if the primary borrower stops making them?
A co-signer often does not have ownership rights to the loan security. For example, they cannot take possession of the car or motorcycle if the primary borrower stops making payments. This is a bit of a lose-lose scenario for the co-signer.
Decreased personal ability to borrow
The co-signed loan will appear on your credit report. This will decrease your personal ability to borrow in the future because of the impact on your credit utilization ratio and debt service ratio.
The more credit you have extended to you, the less you can get in the future. The co-signed loan or mortgage counts as credit extended to you even though you have no ownership rights to the loan item.
Risk of losing collateral
Sometimes to qualify for a loan or get better terms, the co-signer will provide collateral for the loan. This increases the cosigner's risk because if the primary borrower stops making payments, the co-signer could lose the collateral.
Loans that require a co-signer tend to have amortization periods of at least four or five years. Mortgages can have amortizations as long as 30 years (although 25 years is more common in Canada).
When you decide to co-sign for a loan or mortgage, you are in it for the long term. Often it can be difficult to have your name eventually removed from the loan. But it can happen if the primary borrower has improved their credit, increased their income, decreased their overall debt load (for example, by increasing their home equity), or a combination of all of the above.
Read everything first
It is a good idea to get your own copy of all of the loan or mortgage paperwork you sign. And like always, make sure to read everything before agreeing to sign any document. Having your own copies can help protect both you and the primary borrower.
Gain access to account information
As you are responsible for the loan repayment as a co-signer, you should have full access to the loan information.
This way, you can monitor that payments are made on time. And you can keep track of any late payments. A phone call reminder from a co-signer may motivate the primary borrower more than a lender's notice.
Think about insurance
What if something catastrophic were to happen to the primary borrower? You, as the co-signer, would be responsible for the loan repayments.
Consider taking out disability and or life insurance on both parties to protect everyone should something happen.
When to say no to co-signing a mortgage or loan
If a friend or family member asks you to co-sign on a mortgage application or loan for them, there can be many emotions involved. But you always want to make sure that you protect yourself first. Here are three instances when saying no to co-signing may be the best option.
You plan to borrow money soon. Co-signing will decrease your credit and your ability to borrow in the future. If you have plans to take out a loan of your own, co-signing may eliminate your ability to do so. And although you may not plan to borrow money immediately, circumstances can change quickly.
You have concerns with the person's ability to repay the loan. Remember, you are legally responsible for repaying any loan or mortgage you co-sign for. If you have hesitations on someone's ability to repay, that is probably not someone you want to co-sign for.
You don't have stellar credit. There is a chance with less than stellar credit that you may not qualify as a co-signer. But if you do, that loan could decrease your credit to the point where you are now more of a risk to lenders. And it can take months, if not years, to rebuild your credit.
Reasons to co-sign a loan or mortgage
There is a reason that co-signers exist. And co-signing can be a great way to help someone. So, here are three times when you may consider agreeing to co-sign for someone.
You have no plans to borrow in the short term. This also coincides with having good credit and a solid income. You don't want to put your future self at risk by co-signing a loan today.
The loan is for a close family member. Borrowers may have a greater sense of responsibility when the person co-signing is a close relative. They have more invested in the relationship and probably don't want to let you down by defaulting on their payments. An immediate family member is also less likely to disappear and leave you with repayment of the loan.
You genuinely want to help. Co-signing a loan for someone can be the safety net that they need to get back on their feet after an unexpected life circumstance. You can genuinely make a difference in someone's life by signing your name alongside theirs.
Alternatives to co-signing
So maybe you're not ready to co-sign for someone, but you still want to help. Here are some alternatives to helping someone without agreeing to be responsible for the repayment of a loan.
Help out with the down payment. This can reduce the loan amount and increase the chances of approval without needing your signature. Consider helping out in the form of a gift, if you can, so that the borrower isn't further extended with their credit.
Help find another loan source. Just because one lender requires a co-signer does not mean that all of them will. Each lender will have its own lending requirements. And sometimes it's worth taking the time to shop around a little.
Lend your own money. If you are in the position to be able to fund the loan yourself, this can be a great option. But be prepared to lose your money should something terrible happen.