Maybe your car has broken down for the last time and you need a new one. Or perhaps you have home repairs that can no longer be postponed. Whatever your specific situation, you need a loan but can’t qualify on your own. And that’s where the idea of asking a friend or family member to cosign a loan comes in. Before you ask anyone to cosign a loan, though, consider the ramifications. If you decide to proceed, you’ll need a plan.
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Why you might need a cosigner
There are many reasons why you might need a cosigner to land a loan. Here are several of them:
- Insufficient credit history: Building credit can be tricky if you’re new to the country, are a recent graduate, or have lived off the credit grid for some time. You may need a cosigner if you don’t have enough of a credit history to qualify for a loan on your own.
- Irregular income: Let’s say you own a business, and some months you make a lot of money, while other months are slow. You know that you can afford the monthly payments, but it’s tough to prove it to a lender without a steady monthly income.
- Poor credit history: You’ve had credit in the past but had trouble paying it as promised. As a result, your credit score is too low to qualify for a loan without a cosigner.
Understand the risks
There’s no doubt that asking someone to cosign a loan is a huge ask. Even if their credit is near perfect, cosigning a loan for you takes power out of their hands. If you fail to make a payment, their credit suffers right along with yours.
Whether you make the payments or not, the amount you borrowed shows up on the cosigner’s credit report as their debt. This increases their debt-to-income ratio (the amount of debt someone has in relation to their income). And it could make it more difficult for them to gain approval for a loan if they need one before your loan is paid in full. If you die or stop paying, they are legally on the hook to pay the loan.
In other words, asking someone to cosign a loan should not be taken lightly because once they sign on the dotted line, their credit is linked with yours.
How to ask
If you understand the potential risks to another person’s credit but still want to ask them to cosign, here’s how to do it right.
Be clear and detailed about why you need a loan
If you’re going to ask someone to take the risk of cosigning a loan for you, respect them enough to tell them why you need a cosigner. If it’s due to low credit, be honest about what caused your credit score to drop. If your score is due to mistakes you have made, be open about it.
You have a legal right to a free copy of your credit reports from the three credit bureaus once a year. Download those copies and give them to your potential cosigner. It may be a hard conversation to have, but if they’re marrying themselves to your credit, they will likely want to know what they’re getting into — including what kind of credit and spending habits you’ve had in the past.
Give the person the option of being the primary account holder
If your cosigner agrees to become the primary account holder, it means you pay them each month, and they make the payment by the due date. As long as they’re controlling when the payment is made, they don’t have to worry about whether you make it or not. In addition, all correspondence and bills will be sent to the cosigner, so they will always know what’s going on with the loan.
If you’re asking someone to cosign a loan of any kind (including a credit card), offer collateral that’s worth enough for the cosigner to sell if you miss payments. It may be the only way they can afford to pay your debt without ruining their credit. For example, if you need a loan for $5,000, the collateral should be worth at least that much.
Buy a life insurance policy
Although it sounds morbid, the cosigner is still on the hook if you die before your debt is paid. Let’s say you borrow $15,000 to purchase a used car. Before the cosigner adds their name to the loan contract, buy a small life insurance policy that is payable to them in the event of your death. Depending on your age and health, a short-term life insurance policy could be relatively inexpensive.
Come up with an exit date
Typically, you need time to establish your own credit. As you discuss the situation with a potential cosigner, decide when you plan to refinance the debt in your name alone. For example, if you’re taking out a personal loan to make a home repair, promise to refinance or have the cosigner’s name removed in 12-24 months (depending on the condition of your credit).
Put it all in writing
If someone agrees to cosign a debt for you, every detail should be in writing to make it all clear for both of you. Include the following:
- What the loan is for
- How long the loan will last
- Which one of you will be the primary account holder
- When the payment is due each month and how you’ll pay (such as directly into the cosigner’s bank account)
- What you’re offering as collateral
- How many payments you can miss before the cosigner can take possession of the collateral
- Whether you are purchasing life insurance with the cosigner as beneficiary
- When you will provide the cosigner with a copy of the life insurance policy (they should not sign loan documents until you do)
- When you plan to refinance the loan in your own name or have the cosigner’s name removed
- How you will provide proof that the cosigner is no longer responsible for the loan
Once you have a written agreement that you’re both comfortable with, sign it in front of a notary and have the document notarized. Make sure you both have a copy for your records.
Finally, don’t be angry (or surprised) if someone passes when you ask them to cosign. It’s a huge responsibility that offers no benefit to them. If you can find someone willing to take the risk, reward them by carrying through with your end of the bargain.