If someone you’re close to needs to borrow money to buy a home or start a business, you might want to help them out by co-signing. Co-signing a loan can help the person you care about get ahead financially, but it’s a significant commitment that you should enter into with your eyes wide open.
You need to be aware that a co-signer’s rights are limited. Co-signing means promising to pay back a borrower’s loan if the borrower fails to pay. You have the responsibility of repaying the debt, but you don’t have any right to use the loan proceeds.
What Is a Co-Signer?
A co-signer is someone who agrees to be responsible for repaying another person’s loan. If a lender isn’t confident that a loan applicant will pay a loan back, it might insist on a co-signer.
How Is a Co-Signer Different From a Co-Borrower?
A co-borrower is someone who applies for a loan alongside another borrower, has an equal responsibility for repaying the loan and has ownership of the loan proceeds or the asset financed with the loan.
Unlike a co-borrower, a co-signer isn’t legally entitled to any financial benefit from the loan. “There potentially could be a side deal between the borrower and the co-signer where the borrower will compensate the co-signer in some way, but that’s not part of the contract between the lender and the borrower,” says Dave Mawhinney, founding executive director at the Swartz Center for Entrepreneurship at Carnegie Mellon University.
Another difference is that a co-borrower typically plans to help repay the loan. “A co-signer is never intending to be the one paying the debt. Their intention is just to boost the creditworthiness of the borrower,” says Tana Gildea, principal at Homrich Berg, a wealth management firm in Atlanta.
What’s the Application Process for a Co-Signer?
It’s up to the lender how closely to look at a co-signer’s finances.
Most of the time, a co-signer has to go through the same application process as the borrower. The co-signer must provide their Social Security number and give the lender permission to pull their credit. The co-signer may have to show W-2 tax forms and tax returns from previous years and share information about their assets and liabilities.
What Are Your Rights as a Co-Signer?
Co-signing a loan is all about accepting responsibility, and it doesn’t come with many rights. The few rights co-signers have relate to receiving information.
The Right to Receive a Disclosure About What It Means to Co-Sign a Loan
Generally, lenders must give co-signers a disclosure that explains the responsibilities of co-signing a loan, according to a Federal Trade Commission rule. This document says:
- Co-signers should think carefully before agreeing to co-sign.
- If the borrower fails to pay, a co-signer can be held responsible for repaying the full amount of the loan, plus any late fees or collection costs.
- If the loan goes into default, the lender can proceed with collections against the co-signer without first trying to collect from the borrower.
- A default could appear on the co-signer’s credit report.
Some states require lenders to try to collect repayment from a borrower before approaching a co-signer. In those states, this disclosure omits the statement that the lender can collect from the co-signer first.
Real estate purchases don’t have to follow this rule, so co-signers on certain mortgage loans may not get this disclosure.
The Right to Request Information From the Lender on the Loan’s Status
A co-signer can ask to receive information on the loan’s payment history and outstanding balance. Ordinarily, lenders don’t share these details with people other than the borrower, but a co-signer can always ask to monitor the loan’s status – even if it’s been years since they last checked on payments. “You still have the right at any point to come back in and say, ‘Hey, let me look at how it’s been going,'” Gildea says.
Rights You Don’t Have When You Co-Sign a Loan
The following rights do not apply to a co-signer:
- The right to obtain all loan documents. Lenders aren’t legally required to share Truth in Lending Act disclosures, a copy of the borrower’s loan contract or monthly statements with a co-signer. But it’s still a good idea to ask for them.
- The right to the property purchased with the loan. A co-signer isn’t entitled to the loan proceeds and doesn’t become an owner of any assets financed with the loan.
- The right to be removed from the loan. Co-signers can ask for a co-signer release, but it can be challenging to get one. Lenders will typically want to reexamine the borrower’s credit and ability to repay the loan, and they likely won’t release a co-signer unless the borrower could now qualify for the loan independently. Being removed as a co-signer also requires the borrower’s consent.
What Are Your Responsibilities as a Co-Signer?
Co-signing a loan means accepting complete responsibility for it, just as if you had borrowed the money yourself. Co-signers need to complete an application and ensure that the loan is paid back as agreed.
Sharing Financial Information With the Lender
Co-signers must apply to co-sign, which means they have to share their Social Security number with the lender and allow their credit history to be pulled. They’re also responsible for compiling any financial documents that are required, such as tax returns, balance sheets or W-2s.
Monitoring Loan Payments
As a co-signer, it’s your responsibility to make sure the loan gets paid, starting on day one of the loan. To protect your credit, you need to watch the borrower’s payments closely, either by requesting access to monthly statements or communicating regularly with the borrower. If it looks like the borrower is going to be late or miss a payment, you need to step in and pay it yourself – or your credit could take a hit.
Repaying the Loan in Full if the Borrower Can’t
Not only is a co-signer responsible for making any payments the borrower misses, but the co-signer is also responsible for repaying the entire loan amount if the borrower defaults. The lender may be able to sue the co-signer without trying to collect from the borrower first, depending on state law. And if the loan financed the purchase of an asset like a home or car, the lender will typically try to collect from the co-signer before taking the property, Mawhinney says.
Some loans contain auto-default clauses. These provisions allow the lender to demand that the co-signer repay the entire loan amount immediately in certain circumstances, such as if the borrower dies or declares bankruptcy.
Is It a Good Idea to Become a Co-Signer?
Co-signing a loan is a way to help someone you care about get access to credit or get a more affordable interest rate. “A common case is an adult child is trying to get a loan for something. Their credit score isn’t as high or as good as the parent’s, and by adding the weight of the co-signer behind them, they’re then able to get more favorable terms and conditions,” Gildea says.
It might make sense to co-sign a loan for someone you love if you trust them and are confident that they’ll repay their loan. Co-signing involves accepting significant risk, though, so you should be aware of the potential downsides before going ahead with it.
Look at the worst-case scenario, which is that the borrower doesn’t repay their loan. Make sure you can afford to step in and repay the entire debt if needed.
You should also weigh the possible effects of co-signing on your credit score. If the borrower pays late or misses a payment, that can show up on your credit report as a mark against you unless you make the payment in time yourself. And a default on the loan could also show up on your credit report and hurt your credit.
At the same time, making on-time payments for a loan you’ve co-signed can contribute positively to your payment history. “You are making a payment against a loan that exists, and that’s always going to enhance your credit score,” Mawhinney says. Co-signing a loan can also improve your credit mix if the loan represents a credit category that wasn’t already on your record, like if you co-sign an installment loan when you previously had only credit cards in your history.
Co-signing may not be a good idea if you plan to take out a loan soon yourself. Co-signing adds to your financial obligations and raises your debt-to-income ratio, and that could make it harder to get a loan application approved.
Also, you may want to consider whether the loan you’re co-signing is secured or unsecured. If you co-sign a secured loan like a car loan or a home loan, the borrower might be able to sell that asset if they run into financial trouble. That could get both you and the borrower out from under the loan and cap your losses. But if you co-sign an unsecured loan, there’s nothing you can do to recover the money once the borrower has spent it.
Make sure the borrower is someone you have open communication with so you can rely on them to tell you if they’re struggling to make payments. And it’s a good idea to draw up a written agreement with the borrower spelling out that they’ll notify you if their payment is going to be late. That way, you won’t be caught by surprise.