Loans allow you to borrow money for an expense that you can’t pay in full and pay it back over time. Many people take out loans for large purchases, like a car or home. Others take out loans to transfer the balance of an existing loan to one with a lower interest rate so they can pay it off sooner.
Regardless of the purpose of the loan, in certain circumstances, borrowers may be asked to take out a cosigned loan. What is a cosigned loan? Read on to learn more about these loans and what you should know before cosigning.
If someone wants to take out a loan, but they have a low credit score or a short credit history, a credit union or bank may not lend to that person if they’re the only one signing for the loan. Financial institutions want reassurance that the loan will be repaid. A cosigned loan may provide that assurance.
A cosigner is one who agrees to pay the debt if the primary borrower defaults. This means that if the primary borrower doesn’t make their payments, the cosigner becomes responsible for making the payments. This can allow those who are denied a loan based on their own credit to borrow the money they’re requesting, because the bank or credit union now has a guarantee from a more established borrower that the payments will be made.
If you’re asked to cosign a loan, there are many things to consider. First of all, make sure your own finances are in good shape. You don’t want to cosign if you’re struggling to pay your bills, in the middle of a career transition, planning for your own large purchase, or close to retirement.
You also want to make sure the person you cosign for has their own financial situation under control. You may feel differently cosigning for a child who is responsible, but can’t get approved for a loan on their own because they have newly established credit, versus cosigning for someone who has a history of making late payments or taking on too much debt.
In either case, while it may feel good to help someone out, neither of you will benefit if the primary applicant defaults. Talk to them about the plan they have for making payments and ensure you feel comfortable with how they spend their money before cosigning for them. Also, make sure that you have the financial resources available to make the payments, and are willing to do so, if they can’t.
Should you cosign a loan for someone else? A lot of factors play into your decision. We’ve compiled a few considerations below.
There can be advantages to cosigning for someone else’s loan. Here are a few examples.
There are many risks associated with cosigning a loan. Here are a few disadvantages to cosigning for someone else’s loan.
Financial institutions look for someone whose history exhibits financial responsibility. Here are a couple of requirements to be a cosigner.
Cosigning a loan is an important decision and something you should consider carefully. While you want to help someone in need, you need to balance the practical implications of taking on this responsibility.
For more insights on financial decisions, visit our WalletWorks page.