A co-signer is someone who agrees to make a loan on behalf of another person. The co-signer should be financially responsible for the loan, but the responsibility may be shared. The amount borrowed is a “deemed debt” and the co-signer is considered liable to pay it back in full. This article looks at the effect of Co-Signing for a Loan Affects Your Credit in Several Ways and the kind of guidelines that you need to be aware of in order to avoid any damage to your score.
Background Information– Loan Affects Your Credit
Nearly 40 million Americans are looking for a loan to purchase a home, but obtaining a mortgage is difficult and expensive. Those who are looking for a loan are faced with many obstacles, one of which is lending institutions’ unwillingness to lend money. Often times, the mortgage lender asks prospective borrowers to have a co-signer who will agree to pay back the loan if the borrower is unable to.
For those who are approved for a loan, the lender will also want to know that the borrower has a strong history of paying the money back. For someone to have a good history of paying a loan back on time, the lender needs to make sure that the borrower has a solid credit score. A good credit score shows that the borrower has maintained a positive history of maintaining their debt. So, if the borrower has a low score, they will probably be denied for the loan, and if the borrower has a high score, it would be an even harder task for the lender to determine if the borrower will be able to pay back the loan.
Co-Signing for a Loan Affects Your Credit in Several Ways
In this article, I will discuss several ways that co-signing a loan can impact your credit score and the kind of guidelines that you need to be aware of in order to avoid any damage to your score.
1. High Debt to Income Ratio
One of the biggest issues when it comes to co-signing a loan is the debt-to-income ratio. A debt-to-income ratio is the amount of debt that you have in comparison to your monthly income. Generally, lenders will want to see that the ratio is under 45%. But, if you co-sign a loan for someone else, the ratio will not go down to an acceptable level. Typically, someone with a debt-to-income ratio in the range of 80% or higher will be denied for the loan.
To prevent this, you may want to put up a certain amount of your own money as a security deposit to demonstrate that you have enough income to make the loan payment on time and that you are capable of paying back the loan. Another option is to look for an older loan that has a lower DTI ratio in your favor. However, if you do not have any loans with a low DTI ratio in your favor, it is best to avoid co-signing loans altogether.
2. Credit Profile
As previously mentioned, the debt-to-income ratio is the number one factor lenders will consider when they decide to grant or deny a loan. Therefore, if you have a high debt to income ratio, the lender may lower your credit score to see if the score will still be acceptable. If you have a good credit score, the lender may consider granting you the loan because they see that you are a good candidate to take on the loan and make the payments.
3. Recent Payments
When the loan gets approved, the lender will need to make sure that the payment on time. It is important for you to make sure that you pay back the loan within the appropriate amount of time. If the payment on time is not made, it will lower your credit score and make the lender more wary of taking you on as a borrower. It is also important to pay back your co-signer, if you co-sign a loan. If you co-sign for someone else, then they will have to pay back your co-signer if you fail to pay the loan back. So, in the long run, you will end up paying for the loan for both parties.
4. Lower Credit Score
Unfortunately, lenders are looking at the credit score of borrowers more often than their debt-to-income ratio. If your credit score is low, it will be harder for you to get a loan or to get approved for one. They will also look at the credit score of other borrowers when they are deciding to approve or deny the loan to the borrower. This is because if the borrowers with a low credit score are getting a loan, then they will lower the credit score of other borrowers. So, it is better to pay the loan back before you can lower the credit score of other borrowers.
5. Mortgage Loans
Mortgage loans are the most common loans that are co-signed for by borrowers. If you co-sign a mortgage loan, then it is important for you to make sure that you are able to pay off the mortgage loan in full every month. Mortgage loans are usually for a longer period of time, ranging from seven to twenty years. So, if the loan is going to take longer than that to pay, you will end up taking the loan from the lender. If the loan is going to be paid in full by the end of the period, then the borrower will have the option to buy out the mortgage. In this case, the lender will continue to own the loan and will not be accepting payments from the borrower.
It is important that you plan for the loan repayment, even before you sign the loan. You should think of how you are going to pay for the loan when you take it. For instance, if you plan on buying a house and you also plan on taking the loan, it will be better to make the mortgage payment and then buy the house later. It is better to not sign the loan if you cannot pay it back in the agreed time or at the end of the loan period.
Buying a home is a very big financial step. Therefore, it is essential that you think through all the details and plan to pay off the loan and make the mortgage payments. When you get a loan, you are essentially giving the lender the right to take all your financial resources, including your house if you cannot pay the loan in full. You must think through all the details before you sign any loan, especially when it concerns your finances.
6. Potential Credit Turnover
Even if a borrower does not take out the loan in the first place, if a co-signer gets into financial trouble or decides that he or she no longer wants to be responsible for the loan, that borrower may default. Any credit score that is lower than the borrower’s score will be affected. The co-signer’s score will be affected if the borrower defaults. So, you are at risk for being in default even if you are not responsible for the payments.
7. Homeownership Overlap
You may be lucky and find out that the co-signer does not have a significant impact on your credit score. However, a co-signer can have a negative impact on your score. When a borrower gets into financial trouble and is unable to make payments on a loan, he or she may try to get the co-signer to pay it off. If the borrower makes all of the payments, and the co-signer does not, that can have a negative impact on the borrower’s credit score.
8. Credit Covers More Than It Should
If a person has several types of loans, and the co-signer has a loan that covers all of them, then the credit score of the co-signer will be impacted by the combined credit score of the borrower and himself or herself. It could cause the co-signer to have a lower credit score than he or she should have, which could cause the lender to reject the loan.
9. Not Adding Up
If the co-signer does not have enough credit available to pay back a loan, the lender will ask him or her to add the loan to his or her credit card or auto loan. This is called credit crunched or stressed loans. If the borrower is already carrying credit cards and has a loan to co-sign, then this may be the right time to put those cards on hold and focus on paying off the loan.
10. Low Credit Score Can Affect Your Applicance
If you have a low credit score, it is possible that the lender may question whether you can make your monthly payments on the loan. So, if your co-signer has a high credit score, the lender may decide to continue the process of approving your loan until your credit score gets better.
11. Gaps in Payment History
In some cases, the lender may ask the borrower to get a co-signer to help him or her in making the payments. However, there could be gaps in the co-signer’s payment history. A borrower who has a job and makes regular payments will be seen as a solid applicant, but a borrower who has missed a payment or two may not. So, if the lender finds out about the gaps in the borrower’s payment history, they may decide to turn down the loan.
12. A Limited Social Security or Pension Payment History
If a borrower has a limited amount of annual Social Security or pension payments, that could also hurt the borrower’s credit score. If the borrower is old enough to qualify for Social Security or pension benefits, but does not have enough to make the payments, then the lender may ask for a co-signer, who can help them. If the borrower has no income and no source of funds for social security or pension benefits, the lender may turn down the loan.
13. Poor Credit Can Impact Your Lender
A lender can be scared off by a bad credit score. In order to do business with a particular lender, lenders usually check a borrowers’ credit score. So, if a lender knows that you have a poor credit score, then they may decide that you are not a good risk.
14. Role of the Co-Signer
The lender is looking at the borrower and their ability to pay the loan. So, the lender may be unwilling to give the loan to the borrower if they know that the borrower will not be able to afford the payments.
15. Making Assumptions About the Co-Signer
Lenders will often assume that the borrower is able to pay off the loan without the help of a co-signer. The lender may be willing to give the loan to the borrower if they do not have a co-signer, even if it means a higher interest rate.
Loan approval is the only thing that can save you from bankruptcy. Therefore, you should not sign any loan unless it will not impact your financial or family well-being. You must plan your finances carefully before signing any loan and choose a loan that will be appropriate for your needs. If you do not make your monthly loan payments, your lender can take your house and other financial resources if you are unable to pay the loan.
Using a loan to pay off a mortgage is a very risky business. The lender will sell your house and other assets in your name if you cannot pay the loan. For example, if you borrowed money to buy a house, and you could not pay it back, your lender can sell your house and other assets in your name. You have the option to buy out the loan if you do not get a loan approval. So, always think twice before you choose a loan.