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What you need to know before cosigning a loan

Spotlight on Finance

— These are important considerations, because they have an immediate impact on your financial freedom. For example, this new debt obligation will appear on your credit report and will impact your debt-to-income ratio. Debt-to-income ratio is the percentage of your monthly income that must be applied to your repayment obligations to debtors. As a result, your capacity for future borrowing will be diminished. The extent of how much weight this carries in the decision-making process will vary from person to person, as people have different income and debt levels, but it is something that needs to be looked at.

In addition, you are responsible for the actions—or lack of action—of the primary borrower. If your credit score takes a hit because of lack of timely payments and/or failure to make payments, it will impact your financial life and decrease your credit score. This is important because your credit score largely dictates the interest rates you qualify for on future loans or credit card applications. Lower credit scores can increase the cost of your auto and homeowners insurance. Premiums are based, in part, on your credit history. Also, if you want a vacation home, you will pay a higher interest rate on the mortgage. The same is true for auto loans or personal loans.

If you are still willing and able to take the risk as a cosigner, be sure to get copies of all the loan documents, plus the repayment schedules. Research whether you have any cosigner rights under your state’s law. Make sure you understand your obligations under the terms of those documents. Ask the lender to agree in writing to notify you as quickly as possible if the borrower is late with a payment, misses a payment or is otherwise in default. That way you can make the missed or late payment(s) or cure the default to prevent damage to your own credit report.

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