Perhaps you have a friend or relative who wants to purchase a home but does not qualify for a mortgage due to poor or insufficient credit. If your own credit is favorable, you may be able to help this individual by co-signing for the loan, providing the lender with your assurance that the obligation will be met. A co-signing arrangement can pose a number of advantages and disadvantages.
As a co-signer, you are committed to the debt just as much as the person receiving the money. If borrowers don’t qualify for a loan because they can’t make the payments with their own income or they have shown financial irresponsibility in the past, you should reconsider obligating yourself to an agreement that can have a long-term negative impact.
Helping a Loved One
Co-signing for a mortgage loan can give you the satisfaction that comes with helping a loved one get started in life or get back on his feet. Co-signing with your child can help him qualify for a loan so he can purchase his first home sooner than he could on his own, giving him a good start toward establishing financial security. Co-signing also allows you to help someone re-establish credit.
Helping Your Own Credit
Co-signing can help your own credit. As a co-signer, you are as responsible as the other borrower for ensuring the debt is paid. Assuming the other party makes payments on time or you are able to cover the payments whenever she falls short, you are proving to potential creditors you can manage a large obligation.
Your responsibility to make payments also means you are on the hook if your co-signer defaults. If you are unable to make the payments when the other party cannot, your good credit is likely to suffer. And even if payments are made in a timely manner, the additional debt obligation could hinder your future ability to borrow money if your total debt load is too large, especially in the early years of the loan when the outstanding balance is high.
Since co-signing a loan is the same as taking it out yourself, it will be reported to the credit bureaus and become a permanent entry on your credit history report until it’s paid off. Also, if your ratio of balance to total credit available is too high, your credit rating can fall because 30 percent of your score is based on the amount of money that you owe. With a low credit score, it will be difficult, if not impossible, to qualify for a needed loan. In that event, you will not be able to make a large purchase until the entry is removed from your history.
While you may enter into a co-signing arrangement with the best of intentions, things could turn sour in the future. If you happen to be living in the home with the other party, the two of you will need to decide how to handle the arrangement if one of you leaves. If the situation turns hostile and you want to get your name off the loan, it can be extremely difficult to do so.
If the original borrowers on the loan miss a payment or default, creditors will contact you for money. If the debt remains unpaid, collection agencies may work aggressively to force you to do as you committed when you signed the loan contract. You can be sued in court by the creditor. If a judgment is made against you, your wages and bank account risk being garnisheed until the debt is repaid.
Before you co-sign, consider helping the borrower improve his credit rating and wait to apply for a loan on his own. Using a credit card responsibly and paying the balance each month, in addition to paying all his bills on time, will help to improve his score. Alternatively, offer to give him money or make a personal loan, even though it may not be repaid, so that you will not experience the hassle of being responsible for paying back a creditor. However, if you do find yourself in a repayment situation with a lender, negotiate the total balance and try to pay it off so that you can begin to rebuild your credit and savings again.