Typical scenario if a family/friend asks you for a loan; however, have you ever been asked to co-sign for a loan? It raises many questions that need to be resolved if you intend to follow through with it, or not.
Why? Your creditworthiness is a big deal these days. If you’ve got an impressive credit report and score, applying for a loan, credit card, employment, and even mortgage are seamless and with the best interest rates. The reverse is often when your credit score is far from satisfactory.
It stands to reason that anyone who has ever been asked to cosign on a loan wonders if the mere act would affect their credit score. And in our typical fashion, we do our best to discuss every aspect of cosigning concerning credit scores.
HOW DOES COSIGNING WORK?
Let’s consider this scenario:
Your brother, Brian, needs a loan to acquire a vehicle. He has been unsuccessful in his quest because lenders do not consider his request due to his inability to meet some of the requirements to be approved. More so, his credit score is low, and some lenders offer him high-interest rates to scare him off.
Searching for a solution to get approved, Brian begs you to cosign a loan for him. Your stellar credit score will make his request for a loan more appealing to lenders. Brian will not only have his application approved but may enjoy the best interest rates.
Basically, as a cosigner, you’ve helped your brother to qualify for a loan that ordinarily they wouldn’t have been ablet to attain; however, it goes beyond that.
As a cosigner, you have committed to repaying the debt owed by your brother if he doesn’t pay. If the primary borrower defaults on the payment, you must repay the loan plus additional fees accrued. It doesn’t matter if you have no intentions of paying the loan or have zero stakes in the borrowed amount, you are now obligated.
DOES BEING A COSIGNER AFFECT YOUR CREDIT?
When you act as a cosigner for someone applying for a loan, rental agreement, or credit card, you are obligated to pay the borrowed amount if the primary borrower fails to do so. Being a cosigner doesn’t affect your credit initially, other than a small decrease due to the hard inquiry.
Some examples of how it can negatively impact your credit:
- There are missed payments. If the primary borrower is late or misses the payment, and you don’t pay, the creditor can inform the credit bureaus. Every late or missed payment will appear on your credit report, affecting your credit score.
- A cosigned vehicle is repossessed. If you cosign for a vehicle agreement and get repossessed, it will show up in your credit report and lower your credit scores.\
- The account is forwarded to collections. If the primary borrower is late on payments, the creditor can deliver it to a collection account.
- If you are purchasing/planning to purchase a home. It will be factored into your DTI and will decrease the amount of financing you can qualify for.
DOES COSIGNING AFFECT YOUR ABILITY TO BORROW?
When you agree to be a cosigner, it will reflect on your credit report but will not impact your credit score unless there are late or missed payments. Being a cosigner increases your debt-to-income ratio, which lenders consider when approving loan requests.
Having a higher debt-to-income ratio will limit the chances of your request to borrow money approved. That is until the primary borrower pays off their loans on time.
DOES COSIGNING BUILD CREDIT?
Being a cosigner can improve your credit. However, it can only be based on the following factors:
- If the payments are made promptly. Your payment history makes up about 35% of your entire credit score. It reveals whether payments are made on time, how often payments are missed, and how recently you missed payments. If the borrowed money is paid on time (either by the primary borrower or you), it can give your credit score a boost.
- If the new account adds to your credit mix. Your credit scores can also improve if you manage various installment loans and revolving credit.
- If the loans are paid as agreed. When loans are paid as agreed, your credit scores are better for it. Lenders will begin to see you as financially responsible and your future requests to borrow.
Cosigning can benefit your credit, so long as the loan is managed and paid off as agreed; it is just, in our professional opinion, too risky.
DOES COSIGNING AFFECT DEBT-TO-INCOME RATIO?
Being a cosigner to a loan means you’ve taken responsibility to repay the loan if the primary borrower fails to do so. One of the significant impacts is that it affects your debt-to-income (DTI) ratio.
DTI ratio is your monthly debt that is divided by your monthly income. Say, for instance, you earn $7,000 monthly, and your debts for a specific month adds up to $1,500, your DTI ratio (1,500/7,000) is 0.21, which is 21%.
If you cosign for someone, and they’re meant to pay off $700 monthly, that amount will be added to your monthly debts, taking it up to $2,200. Furthermore, this will push your DTI ratio to 0.29, which is 29%.
Your DTI automatically increases when you agree to cosign for someone.
CONCLUSION
Being a cosigner benefits the primary borrower, as it can help them qualify for loan requirements and boost their own credit if payments are made promptly. However, your credit could take a hit with an increased DTI ratio or lower credit scores if the borrower is behind on payments. You should properly review the pros and cons before agreeing to cosign on loan.
Here at The Phenix Group, we are dedicated to improving your credit. We offer free credit analysis, consultations, and strategies to improve and maintain good credit. Reach out to us today.