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Cosigning a loan automatically increases your debt-to-income (DTI) ratio, which weighs your monthly debt obligations against your income. This alone can make it difficult to qualify for a loan, meaning you might have to put that mortgage, car loan or plans to refinance your own debt on hold.
After your credit score, your DTI is one of the most important factors lenders consider on your application. Ideally, your DTI should be below 20% if you want a competitive rate. And most lenders won’t work with you at all if your DTI is above 43%.
Cosigning a loan means you’re as responsible for making repayments as the borrower. If the borrower misses a repayment or defaults, that damaging mark goes on your credit report, too. A flag like this can stay on your report for up to seven years after the first missed repayment.
To avoid this, regularly check in with the loan account to make sure the borrower is making repayments on time.
If the borrower loses their job or otherwise can’t handle repayments, they’re your responsibility now. You also might have to take full responsibility for the loan if the borrower dies and their estate can’t cover it.
Only cosign a loan if you’re prepared to take over repayments. If you’re really worried about affording that expense, some experts suggest taking out a life insurance policy on the borrower so you’re protected in the event of their death.
Once you’re a cosigner, there’s little you can do personally to take your name off the loan. The only way to get out of the responsibility is to have the borrower refinance in their own name.
With some types of loans, such as student loans, they might also have the opportunity to apply for cosigner release. This allows them to keep the same loan but takes your name off of it.
However, this might be an unlikely option if the borrower has weak personal credit or lacks sufficient income to afford repayments on their own. In other words, refinancing and cosigner release won’t help you if the borrower is struggling to make repayments.
If the borrower defaults on the loan and doesn’t make collections payments, both you and the borrower could face a lawsuit. In fact, you might face a lawsuit before the borrower since it’s your responsibility to repay the loan if the borrower reneges. If you lose, you could get a court order to repay the loan in full.
If you and the borrower can’t repay the loan, your lender might agree to settle the debt for a lower amount instead of going through a lawsuit. You might have to pay taxes on the amount that gets forgiven since the IRS considers most cases of debt forgiveness as taxable income.
If the borrower acts irresponsibly and drags your credit score and finances down with them, it can seriously damage your relationship. Rebuilding that trust can be difficult and take years to come back from. If that’s too much of a risk for you, it might not be worth cosigning a loan.
Despite the risks, you might want to cosign a loan in the following situations:
Keep these pointers in mind to avoid damaging your finances with a cosigned loan:
Cosigning a loan comes with more risks than rewards. But there are a few situations where the social benefits may outweigh the potential costs. If you do decide to cosign, be sure to stay on top of the borrower’s repayments.
You can learn more about how borrowing works with our guide to personal loans.
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