When it comes to borrowing money, having good credit is an absolute must. But many people do not, so they must pursue alternative options when they want to take out a loan. One way to do this to have someone else cosign a loan. While this may seem of little consequence for the individual with poor credit, this can be extremely consequential for the person cosigning the loan. If you have been asked to cosign a loan, then you should make sure to fully understand the responsibility you are taking on. Specifically, you should understand what exactly it means to cosign a loan, the potential dangers of cosigning a loan, and the precautions you should take if you do cosign a loan. Read on for a comprehensive guide on all you need to know about cosigning a loan.
WHAT IT MEANS TO COSIGN A LOAN
Let us start by answering the most basic question: what does it mean to cosign a loan? When you cosign a loan, you are acting as a guarantor on the loan. This is because the person taking out the loan usually has a poor credit score, so the lender wants a cosigner as an added layer of security. The primary borrower will be the main person making the payments on the loan, but as a cosigner, you are liable for the loan payments if the primary borrower fails to do so.
DANGERS OF COSIGNING A LOAN
As you probably can already tell from the structure of cosigning a loan, there is inherent risk when you choose to do this for someone else. No matter how much you trust them, there is always a chance that they become unable to make loan payments, and that burden will ultimately fall on you. Aside from this legal liability you sign onto, you also must deal with the fact that cosigning a loan can negatively impact your credit score. That is, a loan means more debt, and more debt can mean a hit to your credit, even if the primary borrower makes all the payments on time.
PRECAUTIONS TO TAKE WHEN COSIGNING A LOAN
Let us now assume that you do decide on cosigning a loan. What precautions can you take in order to mitigate your risk? Well, first and foremost, you should only cosign a loan with someone that you trust, like a family member or close friend. After all, this agreement involves money (sometimes a large amount), so you should only take on this burden if you feel confident that the primary borrower will be responsible with the loan payments.
In addition, there are several precautions you should take individually to protect against your downside risk:
- Budget for potential loan payments
- Keeping an emergency fund for extreme scenarios
- Consider a formal written agreement with the primary borrower to ensure you are reimbursed for any payments you make on their behalf
Taking these steps can ensure that, despite the risk you are taking on, you are well protected and responsibly managing your personal finances.
SHOULD YOU COSIGN A LOAN?
Ultimately, the answer to this question is that it depends. In a perfect world, you would never have to consider cosigning a loan, but this is a plausible scenario that you should be prepared for. If you do end up cosigning a loan, be sure to take the adequate measures to protect yourself!