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Guide to cosigning a loan
Find out what you need to cosign a loan and how it can impact your credit score.
Chances are you’re visiting this page because you’ve been asked to cosign a loan. The good news is that this probably means you have an excellent credit score. The not-so-good news is that cosigning a loan can carry significant financial risks.
Learn more about how cosigning works and the kinds of risks involved.
How does cosigning a loan work?
Cosigning a loan is a fairly simple process that involves attaching your name to a loan in order to “guarantee” the payments for another borrower (usually a loved one). By signing on to the loan, you agree to take on repayments if the borrower is unable to repay their debt. If they default or miss payments, your credit score will also go down.
Having a cosigner can help borrowers strengthen their loan application, get lower interest rates and access credit they wouldn’t be able to get otherwise. The idea is that the added income of the cosigner strengthens the borrower’s debt-to-income ratio to help them qualify for the loan.
There are relatively few benefits for cosigners, other than helping their loved ones get better terms for their loan. However, they may see a small boost in their credit rating if repayments are made consistently and the loan is paid off in full without any missed or late payments.
How is a cosigner different from a guarantor?
The difference boils down to liability. When you cosign a loan, you are contractually obligated to pay it back if the primary borrower doesn’t make their repayments. As a guarantor, there’s a little bit more flexibility.
For cosigners, a lender can come after both you and the borrower immediately for failure to repay. Guarantors only become liable when the lender has exhausted all means of collection against the person who borrowed the money in the first place.
Requirements for cosigners
Cosigning a loan can be a tricky business, and some lenders have strict regulations in place to determine who can guarantee the loan of another borrower. If you want to cosign a loan, you’ll usually need to meet the following requirements.
- High credit score. You’ll need to have a good to excellent credit rating (typically 650 and above).
- Decent income. You may need to show proof of income or enough savings to pay back the loan if need be.
- Stable job and housing. You could be required to prove how long you’ve been employed and have lived at your current address.
- Canadian resident. For some loans, you’ll need to have lived in Canada for a certain period of time to cosign.
- Age of majority. You’ll also have to show proof that you’re over 18 years of age in most provinces.
Does my credit score get affected after cosigning a loan?
Your credit score can be affected both positively and negatively by cosigning a loan. If the primary borrower makes their payments on time, you’ll get a boost to your credit score. It can also help to diversify your credit mix, which can get you a better rating.
If the primary borrower decides not to pay back their loan on time or at all, it can hurt your credit score. On top of that, you may also be stuck making repayments, which could affect your ability to pay back other loans and credit cards on time, further damaging your score.
Will my own loan application be affected if I cosign a loan?
You may have trouble taking out your own loan if you’ve cosigned for another borrower. This is because lenders tend to look at your debt-to-income ratio to figure out if you have enough money to make repayments.
Any loan you cosign for is considered “your debt” even though it belongs to someone else and they’re responsible for repayment. The amount of the loan gets added to the tally of what you owe, and lenders compare this amount against your income to figure out how much you can borrow.
- Rule of thumb: the more money you’ve cosigned for, the less you’ll be eligible to borrow for yourself.
Benefits and drawbacks of cosigning a loan
- Helping loved ones. Cosigning can help your loved ones get better interest rates, qualify for larger amounts or borrow money they wouldn’t have access to otherwise.
- Can improve credit. If they repay their loan on time, you may also get a boost to your credit score.
- Financial risks. Cosigning a loan could leave you in a bad financial situation if your loved one fails to make their repayments.
- Can damage credit. Any missed or late payments will bring your credit score down.
- More debt. You’ll end up with a higher debt ratio, which could make it harder to borrow money for yourself.
- No easy way out. It’s very difficult and in most cases impossible to back out of a loan once you’ve cosigned for it.
What things should I consider before cosigning a loan?
- Debt load. You should look at your budget and find out if you could even afford to make payments if you had to pay the loan.
- Relationship to borrower. How well do you know the person you’re cosigning for? They should be someone that you trust entirely.
- Backup plan. You should find out what happens if the person you cosign for loses their job, gets injured or passes away.
- Cosigner release form. Find out if your lender offers a release to cosigners, and what protection you might be entitled to.
- Regular check-ins. Make sure if you decide to cosign a loan, you keep in touch with the primary borrower regularly to confirm they are making payments.
If you’ve decided to cosign a loan, you should be prepared to accept the financial risks. Learn more about what you’ll need to cosign as well as what things you should consider before you take the plunge.