Cosigned Loans: What Are Its Risks and Benefits?

Whenever you or your loved one is in a tight financial spot and needs a good loan but is unable to because you have an average credit score, you can turn to a friend or someone from your family to cosign a loan. If done responsibly, cosigning is a good choice if you want to get a good loan. 

However, before you or someone you asked for help signs the contract, learning the pros and cons of cosigning a loan is important. 

How Does Cosigning a Loan Work?

Let’s say your best friend Anne is in immediate need of financial support and is looking for a loan with excellent repayment terms and interest rates. However, she has a poor credit score and cannot secure a loan with a  lower interest rate because most lenders are seen as a risky borrower.

But still, Anne is eager to get an outstanding loan, so she requires a third party and asks you to cosign a loan for her. If you have a good credit score, various lenders will find Anne to be less risky, and she’ll have a better chance of getting approved for a good loan. 

In short, cosigning a loan means that you will give your friend or family member a good chance of getting approved of a loan with better repayment terms and low-interest rates.

What Does It Mean to Cosign a Loan?

Cosigning for someone for a loan, lease, or a contract similar to loans, means that you will be paying for the rest of the loan if the original borrower cannot pay for it. Whenever you agree to cosign a loan, it will be shown in your credit report, and depending on how the loan goes, it will impact your credit score either negatively or positively.

Of course, cosigning itself doesn’t harm your credit score. But still, it’s a decision that you shouldn’t take lightly as it can impact your credit score depending on how the loan goes. Before you sign the contract, you should discuss it with the original borrower and talk about how they are planning to repay the loan

It would be best if you also talked about the pros and cons of a cosigned loan if you are a cosigner and how it will affect your finances. Lastly, make sure that the original borrower understands all the loan risks for you when they default.

Always remember that whenever you agree to cosign a loan, your finances will be on the line as you will be responsible for paying the loan 100% when the original borrower defaults on it.

Pros of a Cosign Loan

Here are some of the advantages of cosigned loans:

You can help someone you care about. Financially helping a loved one can make a big difference in their life, especially if they are in dire need of financial support.

Your credit score will improve. If the original borrower is responsible and is making good progress in the loan, your credit score will also improve in the long run since it will also show in your credit report.

Variety in Accounts. Although the variety of accounts is a lesser factor in how your credit score is calculated, it can still improve your credit score. So if you’re looking to improve your credit score, having a cosigned loan is a good thing.

Cons of a Cosign Loan

Here are some of the disadvantages of cosigned loans:

It might limit your loan options. Most lenders will decide whether you can handle a loan by looking at your debt-to-income ratio. Whenever you agree to cosign a loan, it will be added to your debt-to-income ratio, and it might make it seem that you are taking too much debt over your income. This will dissuade lenders from letting you take out a loan from them. 

It can lower your credit score. Like mentioned earlier, the cosigned loan will be added to your debt-to-income ratio and will be shown to your credit report. Hence, whenever the original borrower makes late or missed any payments, it will also reflect on your credit report. The damage would be even more severe if the original borrower defaults on the loan.

You are legally on the line as if the loan is your own. Since you are also legally responsible for the loan, when things go south and the lender decides to sue, you will also be a part of it. The court would also make you pay the full loan along with the legal fees.

You can’t change your mind about it. Once you sign up for the contract, you will be fully responsible for whatever will happen with the loan. This might scare you away from cosigning, and you’ll try to get out of the responsibility. However, you can’t change your mind, even if something bad happens to you financially for the loan duration.

To Conclude

Helping someone financially is a good thing to do, especially if it’s a loved one. However, you have to make sure that they’re responsible for the loan. When they make a late payment, miss one, or worse, default, you’ll also take the fall yourself. It’s important to discuss it first with your partner and make sure that they understand the loan’s consequences for both of you.

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