Cosigning a Loan? Read This First

Often, parents cosign for their sons or daughters who have adequate income but a lack of credit or employment history. By cosigning, parents help their offspring get the loan and establish credit in their own names.

But many borrowers, be they the cosigner or the primary borrower (also known as the maker), don't recognize the magnitude of the responsibilities borne by cosigning a loan.

What responsibilities do you have when you cosign a loan?
Cosigners lend their names and good credit histories to the maker. Should the maker die, lose a job, or otherwise fail to make payments, all responsibility for meeting the terms of the loan transfers to the cosigner.

An often-overlooked aspect of cosigning a loan is the fact that the loan appears on both the maker's and cosigner's credit reports.

If the maker doesn't pay, the lender will notify you to make the payments. In most cases, however, your credit report already will contain the delinquency by the time you receive the notification.

How might a cosigned loan affect your ability to get new credit?
Even if it is not delinquent, a cosigned loan is part of your credit history. Since financial institutions consider a cosigned loan your responsibility, they'll include it when calculating your debt-to-income ratio.

This ratio helps lenders judge whether you have too many bills to pay relative to your income. The cut-off point varies widely among financial institutions and the type of loan. If it's too high, though, the result is the same: your loan application will be denied—even when the primary borrower never misses a payment on the cosigned loan.

Should you cosign a loan?
Before making a decision whether to cosign a loan, consider the following advice offered by Experian:

• As a cosigner, you should know the purpose of the loan, the type of loan, the terms, and why your friend or relative needs a cosigner.
• Understand your legal and financial obligations. Federal law requires financial institutions to tell you in writing that you are responsible for paying the debt if the primary borrower can't or won't make loan payments.
• Read and understand the credit contract. Be aware that a lender may be able to collect from you even when there is collateral. In the case of a car loan, for example, the lender might demand payment from you instead of repossessing the car. And even if the car is repossessed, its value may not be sufficient to pay off the loan.
• If the primary borrower defaults on the loan, then you as the cosigner may have to pay late fees or collections costs in additions to the loan amount.