Co-signing a loan means becoming a loan guarantor. It comes with financial responsibility. If the borrower fails to keep up with the repayments, you will have to repay on behalf of them. Are you considering to become a loan guarantor for any of your friends or family members? You should know the pros and cons of co-signing a personal loan.
If you have a good credit score, and you are managing your finances efficiently, you may be asked by your friends or family to co-sign their personal loan application. Being a co-signor is a huge financial responsibility. And if you do not know what you’re getting into – it may backfire. So, before you say “yes” to someone’s proposal to become a guarantor for their loan put your thinking cap on. Understand the risks that are involved and learn how to manage them. It’s more than just a generous act that can have a significant impact on your financial life.
Let us discuss:
- What does it mean to co-sign a loan?
- 3 things to consider while co-signing a personal loan
- 4 ways to manage your risks as a co-signer
- 2 alternatives to co-signing a loan
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What does it mean to co-sign a personal loans?
When a borrower cannot get their loan application approved due to poor credit scores or no credit history, they may need someone else to co-sign their application. Also, if a borrower receives a quote with a high-interest rate, their lender may ask them to arrange for a guarantor. Using a guarantor while borrowing a loan reduces the rate of interest. Because the risk involved in lending money to someone who has a guarantor is less.
Co-signing a loan application with someone means becoming a guarantor for the loan they are taking out. When you and the borrower co-sign the loan application, you both agree to certain Terms & Conditions related to the personal loans.
Your role as a loan guarantor will be vital if the borrower fails to keep up with the loan repayments. In such situations, you are expected to make the repayments on their behalf. The lender has the legal right to ask you for making the payments.
3 things to consider while co-signing a personal loan
When you become a guarantor for a personal loan you are helping somebody to gain access to finance. But you must gauge the risks that are associated with a guarantor because there is a reason why the lender needs a co-signor in the first place. After assessing a loan application, the lender decides on whether they need a co-signor or not. If they feel that the borrower may not keep up with the repayments, they will ask them to arrange for a guarantor.
Here are 3 risks associated with co-signing a personal loans:
1. It can hurt your credit score
If the borrower makes timely repayment of the loan, it may boost your credit score. Late repayments will hurt your credit score. When you have a poor credit score, it becomes difficult to get approved for loans, mortgages, and credit cards in the future. Even if you manage to find some options, the rate of interest that you will be offered may be high.
A credit check will also be conducted on your profile by the lender while assessing the primary borrower’s credit profile. This check will remain on your report and will have a minor impact on it. However, your report will change according to the borrower’s payment behaviour.
2. You are financially accountable for the debt
A guarantor is a person who co-signs the loan application with the primary borrower. As a guarantor, you are expected to repay the debt if the borrower fails to keep up with the repayments.
The lender can take legal support to recover the money they owe to you. You will be accountable for the unpaid debt and hence, you should evaluate your financial circumstances well ahead co-signing a loan application.
3. Your ability to borrow will be restricted
If you are considering your options for refinancing or buying a new home – you will find it difficult to get your application approved by the lenders. The credit providers will check the entire debt load on you while assessing your loan profile.
If you have too much of outstanding debt or you are responsible as a guarantor for repaying a huge amount, then the lender may not approve your loan application. Co-signing a loan application increases the load of your debt.
4 ways to manage the risks as a co-signor
If you decide to become a guarantor after considering the risks involved in it, then you must know how you can manage those risks. Be prepared mentally and financially as you may have to repay the debt. Co-signing a personal loan for your friends and family is not always a bad financial decision. But before doing so you should know how it will affect your relationship with finance and how you can avert those risks.
1. Effective communication
Communication is the key. Stay in touch with the primary borrower to understand their situation. Know whether they are making repayments on time. Be supportive and help them out if they are facing any trouble with making the repayments.
2. Stay updated
As you are the guarantor, you will have access to the loan information. Keep a track of the repayments. Subscribe to their text and email services so that you receive every update on time.
3. Review your budget
Remember that you will have to make the repayments if the primary borrower defaults at the loan. Therefore, until the loan is paid off, you have to keep a room for breathing in your budget. What if you have to repay the debt? If you also fail to repay the loan, your credit score will take a toll and also, the lender may take legal action against you.
4. Get released from the agreement
After certain conditions are fulfilled, a lender may release the guarantor. But this may vary from lender to lender. Suppose, the primary borrower has been consistent with the repayments and only a few repayments are left, you may ask the lender to release you from the loan agreement.
2 alternatives to co-signing a personal loan
Co-signing a loan is a huge financial commitment as it may have a severe dent on your finances in the long run. If someone from your friends or family asks you to co-sign their loan application, and you think you are not ready to take this financial responsibility, you can consider alternatives.
1. Lend money to them
Instead of asking them to find a deal from a private lender, you can lend them the money. This is only possible when you have substantial cash on you. Review your lending conditions and discuss that with the borrower. Ensure that you clearly communicate about the interest rate that you will be charging and what happens if they find it difficult to manage the loan repayments.
2. Help them with the down payment
Help the borrower to make the down payment. This will result in lower monthly repayments and it will ease the burden on them. Your credit score will not be impacted if the borrower fails to repay the loan. However, there are chances that you may lose the money you have given your friend/family member for a down payment. They may not be able to return it to you. Hence, you must communicate beforehand.
Think twice before co-signing
Being a responsible guarantor for someone’s personal loan is a great idea. People who are trying to build and restore their credit can easily boost their credit score through this option. But you need to be extremely careful because it may backfire if they fail to repay the loan.
Understand what you are getting into and go through the Terms & Conditions carefully. Read the fine print and contact the lender if you find anything that you do not agree to.
