Signing up for a loan is a big financial decision, but so is cosigning for one. Cosigning a loan, simply put, means that you agree to be legally obligated to repay a loan should the borrower fail to do so on their own. On top of agreeing to take on a significant financial responsibility, cosigning for loans can also have substantial consequences on your personal and professional relationships.
Whether or not you should cosign for a bank loan depends on your personal and financial circumstances. However, there are several important factors that you must consider in order to arrive at an informed decision on this matter. If you’re in a position where you are obliged to cosign for a loan, answer the following questions first to determine whether or not it’s sensible for you to say yes.
Are You Ready for the Responsibility You Are Assuming?
There are a few reasons why people look for cosigners for their loans. It can be that the borrower has an insufficient credit history, a poor credit score, or limited income. These make it unlikely for them to get loan approval, higher loan amounts, and better interest rates or terms. Having a cosigner with a better financial profile will improve their chances of having their loan approved or getting the terms that they want. These are the perks that a prospective borrower can access should they be able to get a cosigner.
Cosigning a loan will give you none of these advantages. Rather, it simply makes you equally responsible as the borrower for returning the loaned amount to the lender. In case the borrower defaults on their payments, you’ll have to step up and pay the remaining balance as well as the fees, penalties, and interest to the lending bank. Guaranteeing another person’s loan is a big commitment, and it’s something that you should be seriously ready for even if you have unreserved trust in the financial acumen and personal integrity of the borrower.
Do You Understand How This Will Affect Your Chances of Getting Loan Approval?
Cosigning for a loan can have a negative impact on your chances of getting loan approval yourself. The loan you cosigned will appear on your credit history. This means that if you plan to apply for a loan during the repayment period of the loan you cosigned, the prospective lenders will see that you may have a high existing debt-to-income ratio or that you have more debt than you can handle. Also, in case the borrower misses their payment deadlines, the damage will also be reflected in your credit score and impact your chances of getting loan approval.
Have You Seriously Considered How This Loan Will Affect Your Own Financial Status?
Should the borrower default, the loan you cosigned will be your responsibility. If this happens, how will your finances be affected? Ideally, you should still be able to support yourself and your dependents while paying off a loan that you likely did not benefit from. If you are not realistically capable of shouldering such a heavy responsibility on your own, you should have serious doubts about cosigning for someone else’s loan.
Do You Have the Utmost and Unreserved Trust in the Person Whose Loan You Are Cosigning for?
You likely have an established personal or professional relationship with the person who is asking you to cosign their loan. Considering whether or not to cosign their loan is a good time to evaluate the said person’s financial capabilities and spending habits, their character, and whether or not they will do everything in their power to ensure that you won’t get in trouble for having their back in a time of need. In addition to assessing their financial management capabilities and character, it’s also important to consider whether or not the borrower can treat their cosigner as a partner. If the borrower can preserve their commitment to keep you updated with their progress in paying their loan, then that’s a good sign.
Have You Thought about How This Loan Will Affect Your Relationship with the Person?
Financial pressure can deteriorate personal and professional relationships, and being in debt can certainly increase the level of stress that a person is on. How will cosigning the loan affect your relationship with the borrower? Some parents set expectations with their young adult kids about cosigning their college education loans, so this financial setup does not exactly change the dynamic of their relationship. However, there are also instances where the existence of a loan can cause friction and even relationship breakdowns between the borrower and the cosigner.
Have You Scrutinized the Terms and Conditions of the Loan You Are Cosigning for?
Since you’re assuming as much responsibility as the borrower, you should familiarize yourself with the terms and conditions of the loan. Remember that if you become a cosigner, you’ll be on the hook in case the borrower defaults. As such, you have to know the total amount of the loan, the interest rates, fees, penalties, and the length of the repayment period, at the very least. It’s also important to look into the terms that can impact the borrower’s capability to refinance or modify the loan.
Many people consider cosigning for a loan a last resort since it doesn’t offer a lot of advantages to the cosigner. You can adopt this approach as well and ask whether or not the prospective borrower has considered all possible options for improving their chances of getting loan approval or the terms that they want. But remember that even if they’ve done all they can and getting a cosigner is their last option, consider the abovementioned questions first and whether you can answer them with a resounding yes. If not, then you might not be in the best position to offer assistance to the borrower.