Definition and Examples of a Co-Signer
Andy Smith is a Certified Financial Planner (CFP), licensed realtor and educator with over 35 years of diverse financial management experience. He is an expert on personal finance, corporate finance and real estate and has assisted thousands of clients in meeting their financial goals over his career.
A co-signer is someone who applies for a loan with another individual and who contractually agrees to pay off the debt if the other borrower doesn’t make payments. The co-signer signs the loan application with the borrower and effectively guarantees the loan.
It can be hard to qualify for a loan without a strong credit score and a steady income, and some borrowers might have more success with the help of a co-signer when they’re not able to get approved on their own.
What Is a Co-Signer?
A co-signer is someone who steps in when another individual, usually a friend or a family member, can’t qualify for a loan on their own. This might be because they’re young and haven’t yet established a credit history, or because they’ve had financial difficulties in the past and their credit is less than stellar as a result.
A co-signer is something like a backup plan for the lender. They usually have above-average credit and a solid income. Lenders are more confident about approving a loan when two people are responsible for repaying it, and one of them, at least, is highly qualified as a borrower.
Lenders are more likely to offer favorable loan terms when a co-signer is involved, such as a lower interest rate, more flexible repayment terms, and lower fees.
The lender can pursue both you and your co-signer for the money if you default on the loan. You’re each equally responsible for repaying the full amount borrowed.
Loan Requirements for Borrowers
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Your history of borrowing is one of the most critical factors in getting approved for a loan. Lenders want to see that you’ve borrowed money in the past, and that you’ve repaid those loans on time. Likewise, they want to know if you’re currently behind on payments toward any loans. They’ll certainly be reluctant to approve new debt if you’re already in trouble financially.
Lenders also want to see that you have sufficient income to repay your loans, including any you might already have and the new loan you’re applying for. They calculate a debt-to-income ratio, which looks at how much of your monthly income currently goes toward all of your debt payments. The lower the percentage, the better, preferably no more than 43% in the case of qualifying for a mortgage. ? ?
Your debt-to-income ratio is your total monthly debt payments divided by your gross monthly income before taxes. It would be 25% if you earn $4,000 monthly and $1,000 of that income goes toward repaying debts.
Disadvantages for Co-Signers
Co-signers are responsible for loans even though they might not ever make a payment, so their own credit profile is affected. Future lenders will see on their credit reports that the individual has co-signed and could potentially have to pay off this loan, and this might make the difference between an approval and a rejection. ? ??
Co-signers should be reasonably sure that they personally won’t have to borrow in the next few years, or that they have sufficient income and such superior credit that an additional loan on their credit report won’t have much of an impact.
The co-signer’s credit will suffer if they’re unable or unwilling to repay the loan and the initial borrower defaults. It’s just as though they applied for and took out the loan themselves. The lender will report the missed payments to credit bureaus if the loan isn’t paid, and the co-signer’s previously strong credit will deteriorate.
