What Does Co-Signing a Loan Mean?

Couple getting auto loan
Mar 27 2024

What Does Co-Signing a Loan Mean?

Co-signing a loan means you are legally responsible for repayment of someone else’s debt. You’re lending your good name and your solid credit history to help someone else get approved for a loan or a credit card. And you’re making a promise to repay in full if the original borrower can’t or won’t.

Impact of Co-signing

  • Your credit score could change. The amount of the debt and any missed payments become part of your own credit history. A lower score could make it harder for you to qualify for a future loan.
  • If the borrower defaults, collectors might come to you for payment. For example, if the borrower defaults on a car loan and the car is repossessed, you may have to pay if its value is not enough to cover the outstanding balance.

Co-signing is serious business. That said, there are good reasons to co-sign a loan in certain situations.

Co-signers can help young family members

If you have a solid credit history and a strong credit score, your additional signature on a loan could lower the rate. Young adults often have little or no credit history. Applying on their own, they could face higher rates (to cover risk to the lender) or be turned down entirely.

Say your 22-year-old daughter Megan is ready to buy a car. She has a steady job and can handle the payments, insurance, and upkeep—but she has no credit history. You think she’s responsible enough to handle this obligation, but to a lender she’s an unknown risk; a lender might offer a higher rate to compensate for the risk.

By co-signing, your strong credit score could reduce that rate.

How to make it work

Follow these three guidelines to make co-signing successful:

  1. Set up automated payments. Before co-signing  a loan, insist that the borrower set up automated monthly payments from a credit union account. The payments should cover at least 5% or more of the balance.
  2. Agree to limits.  For a loan, make it clear you’ll act as a co-signer for just three years; then visit the credit union to renegotiate the loan without your signature.

For a credit card, start with a low limit—say $500 to $1,000. As a co-signing parent, you’ll be notified of any request to raise the credit limit. And once your son or daughter reaches age 21, have your name removed from the account.

  1. Share payment notifications. As a co-signer, you have the right to see statements and payment notifications. The easiest way may be through shared online access. This gives you the opportunity to step in before an accidentally missed payment turns into a past-due problem.

Be a credit coach but avoid criticizing the borrowers credit card purchases. Yes, a new jacket is not practical when there’s a perfectly good one in the closet, but making mistakes is part of learning to manage money. The borrower soon will learn that paying off that new jacket means taking on a couple of extra shifts.

Be sure to talk with someone at the credit union if you have any questions or concerns.

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