About Co-Signing a Loan

Co-signing a loan involves taking responsibility for a debt along with another person. Generally, the person who is interested in taking out the loan is the principal borrower. The principal borrower asks another person--the co-signer--to co-sign for the loan. This means the co-signer is taking responsibility for, or guaranteeing, the loan.

What Does It Mean to Co-sign a Loan?

Co-signing a loan means you are responsible for that loan. You are guaranteeing it. In other words, you are promising the lender that if the person borrowing the money does not pay the loan back, that you will pay the loan back.

Each person borrowing money--including any and all co-signers--is jointly and severally liable for the money. This means that if the other borrowers do not pay the money back, or do not pay some portion of the money back--the co-signer or co-signers will be responsible for paying it back. The creditor can require the co-signer to pay back the entire unpaid amount of the loan, including fees and interests, even if the co-signer never had possession of the money or the item lent.

Why is a Co-Signer Needed?

There are a number of potential reasons a co-signer may be required. Generally, the principal borrower does not have the credit score required to get the loan on his own. A low credit score can occur because the borrower owes more money than the credit bureau feels is responsible, or because the person has too much credit available to him in relation to his income. The borrower may have a poor payment history. The borrower may have declared bankruptcy in the past and/or have judgments against him or collections for unpaid debts. Finally, the borrower may just not have a history of using credit, and his score may be low due to this lack of history. For whatever reason, the person lending the money does not believe the borrower is a good lending risk. Thus, the lender require another person to co-sign, or guarantee, the loan.

A co-signer also may be needed to lower the interest rate on the loan. The principal borrower may qualify for a loan, but with a high interest rate because he is seen as a poor credit risk. A co-signer with a good credit score can make the lender feel more at ease about the transaction.

Risks of Co-Signing

If you co-sign for a loan, you are responsible for that loan even if you never had possession of the money or the item lent. You may be responsible for paying the loan back if the borrower defaults or does not pay a portion of the loan back. In addition, if the other borrower dies, you are still responsible for paying back the unpaid balance of the loan.

Because you co-signed for the loan, the loan shows up on your credit report as your debt. It is thus factored into your credit score. Your credit score is determined by: the amount of money you have available to borrow, the amount of money you have borrowed, in relation to the amount you have available to borrow and your payment history.

Co-signing a loan can make it appear you have more credit available to you. If you co-sign for a credit card, and then you or one of the other borrowers "maxes out" the credit card--or uses the entire amount of available credit--this will adversely affect your credit score. If any other borrowers are late with payments, this will be reflected on your credit report and can lower your score.

Who Should You Co-Sign For?

You should only co-sign a loan for people you trust to pay back the loan. This can include close family members or friends who have a history of being responsible with money, but it is still a risky decision.

Types of Loans that can be Co-Signed For

Generally, a co-signer can guarantee any type of loan, including secured debt and unsecured debt. Secured debt is debt that has an asset that can be repossessed associated with it. A mortgage and car payments are secured debt because if the payments are not made, the lender can take the house or the car back. Unsecured debt includes credit cards and personal loans. The money is lent and there are not necessarily any assets a lender can take back if the money is not repaid. Student loans are technically unsecured debt, but they are often guaranteed by the government and can't be discharged in bankruptcy.