5 Things to Know Before Cosigning a LoanOctober 2, 2020
With interest rates on student loans at historical lows, 2020 offers the opportunity to obtain student loans at desirable interest rates, along with the ability to refinance student loans to a lower interest rate. Receiving a lower interest rate allows you to save money when repaying student loans by decreasing the amount of interest that you will have to pay over your loan term.
While it is appealing to take advantage of these lower interest rates, meeting the eligibility requirements to obtain a student loan or refinance student loans can be a barrier to obtaining these lower rates. One option for individuals who don’t meet the credit score or income requirements for obtaining a loan is adding a cosigner who does meet the requirements to guarantee the loan. However, consigning a loan comes with responsibilities. Here are several things to know before consigning a student loan or a refinanced loan.
You are held responsible for the entire loan
While cosigning a loan can seem like a simple favor to help a friend or family member, it actually means that you are held responsible for the entire loan amount. Cosigning a loan means that you are obligated to make payments on the loan if the primary borrower is unable to do so. While the borrower may be financially able to make consistent payments now, it’s important to keep in mind that their situation can change for the worse, whether it be through losing employment, unwise financial decisions, or simply being irresponsible.
Before cosigning a loan, be sure to take stock of your current and potential future financial situation to ensure you will be able to make payments if the primary borrower cannot.
Your credit is at stake
When you cosign a loan, the loan and payment history shows up on your credit report as if the loan is your own. When you first cosign, the lender will conduct a hard credit pull, making an immediate impact on your credit score. The overall amount of debt will also be added to your credit report, which can also affect your credit score.
This means that any missed payments will affect your credit score negatively. Since payment history is one of the biggest factors in your credit score, it’s important to make sure the primary borrower is making their payments and that they are aware that a missed payment affects your financial future as well.
Additionally, since cosigning a loan adds to your total debt, cosigning a loan may affect your access to credit in the future. Creditors will take this debt into consideration before approving you for additional credit. It’s recommended to keep an eye on your credit report after cosigning a loan to make sure it’s still in good shape.
You can be subject to legal action by the lender
Depending on the state you live in, lenders can pursue legal action against you on debt that goes unpaid for a significant period of time. If several missed payments occur, you may be liable to be sued for nonpayment. This typically occurs when the debt goes unpaid for 90 to 180 days, but the law varies in different states, and protocol varies by lender.
If legal action commences, the cosigner will be responsible for any and all costs, including but not limited to lawyer fees. While this doesn’t typically occur, keeping in mind the worst-case scenario is still important.
Removing yourself as the cosigner can be difficult
Another consideration to have when cosigning a loan is that it’s not always easy to remove yourself as a cosigner down the road. If you need to eliminate the liability of the cosigned debt in order to receive a personal loan, mortgage, or another type of credit later on, you may find yourself wanting to be released as the cosigner.
Refinancing a loan is one way to remove a cosigner, however, the primary borrower will have to qualify for the new loan in order to do so. Typically, lenders will require the primary borrower to establish a history of on-time payments before they assess whether the borrower can responsibly take on the loan themselves.
Your relationship could be at risk
While not a major financial risk, cosigning a loan can cause a divide in your relationship with the primary borrower if repayment doesn’t go according to plan. While the primary borrower may have all plans to responsibly manage the loan, if things worsen and you as the cosigner aren’t made aware, you may be fairly bothered by how the borrower’s actions have affected you. It’s important to establish a trust that the primary borrower will be transparent with you so that the loan doesn’t cause a problem with your relationship with them down the road.
When it comes down to it, cosigning a loan comes with risk, and should only be done when necessary and if you fully understand the consequences if things don’t go according to plan. If you’re looking to release yourself as the cosigner of a loan, read our blog, Cosigners and Cosigner Release: What You Need to Know.
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