What is a Cosigner? How Lenders Reduce Risk for Borrowers with Credit Issues

A cosigner is someone who helps you get a loan or credit card by promising, in writing, to pay the loan if you cannot pay it back. This makes it easier for you to borrow money, especially if you need help getting credit.

In this article, I’ll help you understand cosigning, when it can be advantageous, and how risky the strategy is when building credit.

A credit card or lender may need additional reassurance on your ability to repay a loan, especially when you have bad or no credit. This is where a cosigner can help.

Cosigners add their signature to a loan or credit card agreement and assume equal responsibility for payments. This can help you get the loan or card you need.

Why You May Need a Cosigner

You may need a cosigner for a loan for a few reasons. Cosigners play a role similar to collateral in that they reduce the risk that the lender won’t collect its loan.

You Have Bad or Limited Credit

Lenders may require a cosigner if you have a poor or limited credit history because they are nervous about receiving timely repayment. A cosigner helps because they promise to pay back the loan if you can’t. This gives the bank more confidence to lend you money.

With a cosigner who has good credit, your chances of getting approved for a loan increase. The lender looks at the cosigner’s history of paying back loans on time, which helps balance out your poor or limited credit profile.

Not only can a cosigner help you get approved, but they can also help you get a loan with better terms. This may mean a lower interest rate or a larger loan amount than you could get on your own. Lower interest rates can save you a lot of money over time.

When a cosigner helps you get a loan and you make your payments on time, you can start to build or improve your credit score. This is important because a better credit score will help you qualify for loans without needing a cosigner in the future.

In other words, a cosigner is not just someone helping you with a loan; they also help you build your trustworthiness with lenders for the future.

You Have a High Debt-to-Income Ratio

Large loans relative to your resources (i.e., income and assets) are another reason a lender may require a cosigner. Big-ticket purchases, such as a house or car, may require you to borrow more than the lender considers prudent. 

Lenders usually set limits on a borrower’s debt-to-income (DTI) ratio and may reject applications if it is too high. Your DTI ratio equals the sum of your monthly debt payments (e.g., credit card payments, car loans, student loans, and mortgage rent) divided by your total monthly income before taxes and deductions:

Lenders use this number to decide if you can manage more debt. A lower DTI ratio (i.e., 20% or 30%) is good because it means you aren’t using a lot of your income to pay debts. A higher DTI ratio (typically 40% or more) may make it harder to get new loans because it shows you already have a lot of debt compared to what you earn.

If you have a high DTI ratio, a cosigner can help you secure a loan. The lender combines the debts and expenses of the two signers to calculate a composite DTI ratio that may be significantly lower than yours alone.

For example, imagine Jack is a 30-year-old graphic designer who wants to buy a new home. He makes $3,000 a month before taxes and deductions.

However, Jack has a lot of debts: a $500-a-month car loan, $400-a-month student loans, and $350-a-month credit card payments. This adds up to $1,250 in debt payments each month.

Jack’s DTI ratio is ($1,250 / $3,000) × 100 = 41.67%. This is quite high, and banks usually prefer a DTI ratio under 36% for substantial home loans.

Emma is Jack’s aunt. She’s an experienced nurse making $4,500 a month. Emma has fewer debts: a mortgage payment of $700 and no other significant loans. Her DTI ratio is ($700 / $4,500) × 100 = 15.56%.

Emma’s DTI is very good, showing she manages her money well and has a lot of her income left over after paying her debt. When Emma agrees to cosign, the bank looks at both their incomes and debts together:

With Emma as a cosigner, the combined DTI is much lower than Jack’s alone. This 26% DTI is within the bank’s preferred range.

The bank sees the lower composite DTI ratio and feels more confident about lending Jack the money. Jack gets the loan to buy his new home, thanks to Emma’s good financial standing and willingness to help.

This story shows how having a cosigner with a good financial record can help you secure a larger loan by lowering your DTI ratio and making you look better to lenders.

You’re Young

Borrowers under 21 years of age, including college students, are subject to the Credit CARD Act of 2009, which has specific rules about how people between 18 and 21 can get a credit card.

If you fall into this age range, the law requires you to show that you have your own income to pay back any money you spend on the credit card. This income could come from your job or other sources.

If you can’t show enough income, you can still get a credit card if an adult, such as a parent or another relative, agrees to be your cosigner. The cosigner promises to pay your credit card bill if you can’t.

These rules exist to help young people avoid getting into debt they can’t manage. By requiring proof of income or a cosigner, the law aims to ensure young consumers are financially ready to use a credit card.

Loans That Allow Cosigners

Some loans let you use a cosigner, which can make it easier for you to get approved. Here’s a rundown of popular loan products that permit cosigners.

Student Loans

Many private student loans allow cosigners because students often don’t have enough credit history on their own. The loans are typically significant because of high tuition costs, which range from a few thousand dollars to more than $50,000 per year, depending on the college you attend.

Generally, private student loans focus more on the cosigner’s credit and DTI because many students have little income. The cosigner’s DTI should ideally be below 40% to help secure the loan.

The role of cosigners is quite limited in the case of federal student loans. Most federal student loans, such as Direct Subsidized and Direct Unsubsidized loans, do not require a cosigner.

These loans are available to students based on their enrollment in school. They are not dependent on credit history or income, which is why a cosigner isn’t necessary.

For federal Direct PLUS and Parent PLUS loans, borrowers may not qualify on their own if they have an adverse credit history. In such cases, they can apply with an endorser, who is similar to a cosigner.

The endorser agrees to repay the loan if the borrower cannot. This is typically the only type of federal student loan that involves someone else in the loan approval process due to credit issues.

Unsecured Personal Loans

An unsecured personal loan is a type of loan that doesn’t need any property (e.g., a house, car, securities) as collateral. This means that if you can’t pay back the loan, the lender can’t automatically take your property. 

However, not having collateral makes these loans riskier for the lender, so access is restricted, and interest rates are higher than for secured loans. 

Many personal loan providers allow cosigners. This can help you secure a loan with a lower interest rate. Personal loans usually range from $1,000 to $50,000 or more, depending on the lender and the borrower’s needs.

Lenders that offer personal loans usually prefer a DTI ratio under 36% but may accept higher ratios if you produce a strong cosigner. The exact requirements vary by lender.

Auto Loans

When buying a car, having a cosigner can often lead to better loan terms, especially if your credit isn’t great. The loan amounts depend on the price of the car, but auto loans can typically range from $5,000 to more than $70,000 for high-end vehicles.

As with personal loans, an ideal DTI for auto loans is usually below 36%. However, lenders may be flexible if the cosigner has a good credit history.

Auto loans are easier to get than unsecured loans like personal loans because they involve collateral. This means when you take out the loan, you agree that if you can’t pay it back, the lender can repossess the vehicle you purchased with the loan.

This reduces the lender’s risk, making it more willing to lend you money, often at lower interest rates.

Mortgages

A mortgage is a loan to buy, build, or rehabilitate a home. The amount of a mortgage varies greatly, generally depending on the price of the home being purchased. These loans are typically in the hundreds of thousands of dollars.

Mortgage lenders often look for a DTI ratio of 43% or lower. A lower DTI ratio indicates that borrowers have a good balance between income and existing debts, which suggests they can manage additional monthly mortgage payments.

Suppose the primary borrower’s DTI ratio is too high. In that case, a cosigner with a lower DTI can help by adding their income to the equation, potentially lowering the overall DTI ratio to within acceptable limits.

Federally guaranteed mortgages, including loans from the FHA (Federal Housing Administration), VA (Veterans Affairs), and USDA (United States Department of Agriculture) generally have more lenient DTI requirements:

The U.S. government backs federally guaranteed loans, which reduces the lender’s risk of loss if the borrower defaults. This backing allows these programs to accept higher DTI ratios. 

In contrast, private lenders don’t have government insurance to fall back on. They’re more exposed to losses if a borrower defaults, so they often require lower DTI ratios to minimize their risk.

Private mortgage insurance (PMI) can help further mitigate that risk. It is a type of insurance that you may need if you buy a home with a down payment that’s less than 20% of the home’s value. 

PMI protects the lender — not you — if you stop making payments on your loan. Since lenders view small down payments as more risky, they may require PMI to cover this added risk.

PMI is not a substitute for a cosigner, as they serve different purposes. PMI helps reduce the risk to the lender when a borrower makes a smaller down payment. It also allows borrowers to qualify for a loan that they might not otherwise qualify for. 

A cosigner directly enhances the borrower’s loan application by adding another creditworthy individual to the agreement. This can help a borrower qualify for a loan or get better loan terms because the cosigner agrees to pay the loan if the original borrower cannot.

Having a cosigner can help you gain approval for a mortgage or get better terms because it lowers the lender’s risk more directly. PMI, on the other hand, does not affect the terms of the loan or the interest rate you receive.

With or without a cosigner, failure to keep up with the mortgage payments may prompt the lender to evict you and foreclose on the house.

Credit Cards

Most major credit card issuers no longer accept cosigners. Those include American Express, Bank of America, Capital One, Chase, Citi, Discover, and Wells Fargo.

Smaller credit unions and regional banks are card issuers most likely to permit cosigners. The major exception applies to some student credit cards, which are more likely to accept cosigners.

Both you and the cosigner need to fill out the application together. You need to share information such as how much money you make, where you work, and your Social Security numbers.

The credit card company examines both your credit histories and determines whether it trusts both of you to pay back any money spent on the credit card.

The issuer looks at how good the cosigner’s credit is. If you don’t have great credit, the cosigner’s good credit might help you get approved.

The cosigner must agree to help pay off any money spent on the credit card if you don’t pay it. On-time payments can help both your and the cosigner’s credit.

Typically, you will use the credit card and pay the bills. The cosigner should monitor the account to ensure you make payments on time, which helps avoid problems with your credit.

A cosigner must completely back your loan or credit application. This means if you can’t pay back the loan, the cosigner has the means to pay it. Let’s look at who can be a cosigner and what qualifications they need.

Typical Requirements

A cosigner should have a good credit score, typically around 700 or higher. This shows that they have a history of managing their credit well. A record of missed payments, defaults, or bankruptcies can disqualify someone from cosigning because it suggests a risk of non-payment.

Cosigners require income high enough to cover the loan payments if the primary borrower can’t make them. This reassures the lender that the cosigner can manage the payments if necessary. Insufficient income, regardless of a good credit score, can disqualify someone as a cosigner.

A low DTI ratio for the cosigner is important because it means they can easily manage their own debts. This is crucial because if the cosigner needed to start paying for your loan, they should be financially capable of doing so.

People currently undergoing bankruptcy proceedings usually do not qualify as cosigners. Bankruptcy significantly impacts both credit and financial stability, and lenders view them as less dependable loan guarantors.

Each lender may have specific requirements or exceptions, but these general guidelines hold across many types of loans. You and the potential cosigner should review these criteria carefully before applying for a loan together to see if you are eligible.

Relationship to the Primary Borrower

Cosigners are often people who have a close and trusting relationship with the primary borrower. The most common cosigners are parents, siblings, or other close family members. They usually want to help their loved ones succeed or achieve something important, such as getting an education or buying a car.

A very close friend might agree to cosign if they have a strong, trusting relationship. However, both parties should understand the risks involved — including a possible end to the friendship if the primary borrower stops paying.

Sometimes, spouses or significant others may jointly apply for a loan, especially if they earn income and share financial goals, such as buying a home.

Being a cosigner is a big responsibility. You need to have a good financial standing and a close relationship with the primary borrower.

Both you and the cosigner should understand the risks and commitments involved before signing any agreements. This can help prevent financial strain and preserve your relationship in the long run.

When you cosign a loan, you agree to assume responsibility for someone else’s debt if they can’t pay it. 

This is a big financial decision, so it’s important to know what you’re getting into. 

Risks for Both Parties

Cosigning can help a friend or family member get a loan that they might not qualify for on their own. However, there are risks involved for both the borrower and the cosigner:

Credit Risk: If the borrower doesn’t make payments on time, it will hurt the cosigner’s credit score, as well. Because the loan appears on both credit reports, any negative information will affect both parties.

Financial Risk: As a cosigner, you are legally responsible for the loan. You have to make the payments if the borrower cannot. This can be a heavy financial burden, especially if you aren’t prepared for it.

Relationship Risk: Money issues can cause a great strain in relationships. I discuss this dynamic in greater detail later on.

Loan Approval Risk: Being a cosigner on a loan can affect your ability to qualify for loans in the future. Lenders consider the cosigned loan as part of your debt when you apply for new credit, which could make it harder for you to borrow money.

Legal Risks: If the debt goes unpaid, creditors may come after cosigners for payments in addition to the primary borrower. In some cases, this could even lead to collections and legal action to recover the money.

These are significant risks, and they show why cosigning should not be taken lightly. It’s crucial for the cosigner to trust the borrower. Both parties also need a clear agreement about who will make payments and how they’ll communicate about the loan.

Benefits for the Primary Borrower

Cosigners benefit primary borrowers, especially those with subprime credit. The borrower can benefit in the following ways:

Easier Approval: Having a cosigner helps you get approved for a loan and may provide access to loans that might otherwise be unavailable.

Better Loan Terms: Cosigning can result in lower interest rates and better loan terms. These can significantly reduces the cost of borrowing, and save you money.

Credit Building: This arrangement can help build or improve your credit score. That, in turn, can make it easier to secure future loans and maintain financial stability.

Financial Education: A Cosigner can teach a borrower more about credit management and responsibility. 

Recruiting a cosigner can provide a borrower with considerable support, especially if they are just starting your credit journey or trying to improve their financial profile.

How Cosigning Impacts Relationships

When you cosign a loan for someone, such as a friend or family member, it can change your relationship. This happens because cosigning means you promise to pay the loan if the other person can’t.

It can feel stressful if the person you helped fails to pay the loan. You might worry about having to pay their debt, and this worry can make things uncomfortable.

Money problems can lead to arguments. You’d likely feel upset or frustrated with the primary borrower if you had to pay for their loan. This can make it hard for your relationship to continue as normal.

If things go really wrong, and the borrower can’t pay at all, you may end up having to spend a lot of money. This can make you feel regret about helping out in the first place.

So, when you think about cosigning, it’s important to talk about everything that could happen with the person you’re helping. This way, you both understand and are ready for what’s involved. This can help keep your friendship or family relationship strong, even if things get tough.

Weigh the Pros and Cons Based on Your Situation

When you’re thinking about adding a cosigner to a loan, it’s vital to consider the pros and cons based on your own situation. Here’s how you can assess whether cosigning is a good decision for you.

• Think About Your Financial Health: Ask yourself if you can manage paying the loan on your own even if the cosigner can’t pay it back. Make sure it won’t disrupt your finances. Remember, it can hurt the cosigner’s credit score if the borrower skips loan payments. Are you comfortable making timely payments over the life of the loan? If so, you can contribute to your credit score and your cosigner’s.
• Consider Your Relationship: Make sure you really trust the cosigner and vice versa. Talk openly about money and make sure you understand how important it is to make payments on time. Discuss what will happen if money gets tight. Decide how you will manage things if you can’t make the payments. This may prevent arguments later (although I wouldn’t count on it).
• Understand the Full Commitment: Remember that cosigning is not just helping with a loan now. It could be a long-term commitment, and you may both need to monitor the loan for many years. Know that, legally, cosigners are just as responsible for the loan as the borrower. This means the lender will expect the cosigner to pay if the borrower doesn’t.

After considering these points, if the cosigner feels confident in your financial responsibility, and your relationship, this situation can really help. 

However, if the cosigner has doubts, especially about the borrower’s financial safety or trustworthiness, it may be better to not enter this type of agreement. This can be tough, but it can save both parties from financial problems and stress down the road.

Becoming a cosigner is a big responsibility. Make sure you understand what you’re getting into before agreeing to cosign — or ask someone to cosign for you.

Sharing Liability for Debts

If the borrower can’t pay back the loans, the cosigner must pay instead. As the cosigner, you legally agree to take over the payments, which means you are as responsible for the debt as the person who originally took out the loan.

This shared liability means that any money that the borrower owes becomes your responsibility, too, if the borrower fails to make payments. Being a cosigner is a serious commitment because it involves promising to pay back someone else’s debt if they can’t manage it themselves.

Consequences of Missed Payments

Late or missed loan payments affect both the borrower and the cosigner as both of their credit scores will suffer. This happens because the loan is linked to both the borrower and the cosigner.

When a payment is missed, it shows up as a negative mark on both credit reports. This can make it harder for both parties to qualify for financing in the future because other lenders see that you didn’t pay a loan on time.

It’s important to keep up with payments to avoid hurting your credit scores.

How Cosigners Can End the Agreement

When you cosign a loan, ending your responsibility as a cosigner can be challenging, but it’s not impossible. Here are some conditions that can release you from a cosigning agreement:

Loan Refinancing: The primary borrower can refinance the loan on their own. This means they take out a new loan to pay off the original one, but this time, it is only in their name. They will need to have good enough credit and income to qualify.

Loan Repayment: Your responsibility as a cosigner ends automatically when loan repayment is complete. This can happen through regular payments or if the borrower decides to pay off the loan early.

Cosigner Release Option: Some loans have a cosigner release option. This means after the primary borrower makes a certain number of on-time payments and meets certain credit requirements, you can apply to be removed as a cosigner. You should check the loan agreement to see if this option is available and its specific requirements.

Loan Forgiveness or Discharge: In rare cases, the lender may forgive or discharge a loan due to specific circumstances such as school or company closing, permanent disability, or other reasons defined by the lender or the law.

Borrower Fraud: If the borrower commits fraud, such as providing false information on the loan application (e.g., overstating income or not disclosing other debts), and this is discovered, the lender may call the loan due immediately. As a cosigner, you could be held responsible for repaying the full loan amount quickly because you signed the agreement under the assumption that all information was truthful. However, you may be able to sue the borrower. This legal action may help you recover any losses you incurred as a result of having to pay back the loan or other damages caused by the fraud.

Lender Fraud: If the lender has engaged in fraudulent activity, such as not disclosing certain loan terms or misleading both the borrower and you about the nature of the loan, you may have grounds to challenge the legality of the loan agreement. In such cases, you can take legal action to nullify the loan, releasing you and the borrower from further obligations under that agreement.

It’s a good idea to educate yourself on the lender’s policies and your legal rights before you take steps to end the agreement. Being proactive and informed can help you manage your responsibilities as a cosigner.

If you can’t find a cosigner, you may still find other ways to manage your credit needs. Some methods include becoming an authorized user, securing a credit builder loan, or using other financial tools to help you build your credit over time.

1. Become an Authorized User

Being an authorized user on someone else’s credit card is somewhat similar to having a cosigner — with a few key differences. Here’s how it works and how it compares to having a cosigner:

– What It Means to Be an Authorized User 

As an authorized user, you get a credit card linked to another person’s account. This means you can use your copy of the card to make purchases just like the account owner.

Unlike a cosigner, you are not legally responsible for paying the credit card bill as an authorized user. The primary account holder is still responsible for making all payments.

– Similarities to Having a Cosigner

Both situations can help you build your credit history. When you’re an authorized user, the account’s activity — good or bad — shows up on your credit report. If the account is managed well, it can help improve your credit score.

Just as with a cosigner, card activity can help or hurt your credit. Your credit report looks good when the primary cardholder pays the bill on time and keeps the balance low. But it could hurt your credit score if they miss payments or max out the card.

– Differences from Having a Cosigner

Being an authorized user carries less financial risk compared to having a cosigner. A cosigner agrees to pay the debt if the borrower can’t, putting both parties on the hook for the debt. Authorized users don’t have this obligation.

Cosigners also do not have any control over how the primary borrower uses the credit. In contrast, as an authorized user, the primary user can control how you use the card — and remove you.

Overall, being an authorized user lets you benefit from someone else’s credit without the financial responsibilities that come with being a cosigner. It can be a good stepping stone to building credit, especially for young people or those new to credit.

2. Build Your Credit Over Time

Building your credit over time is important if you want to borrow money in the future. Here are some strategies to help improve your credit score:

• Pay Bills on Time: Always pay your credit cards, rent, utilities, and other bills on time. This helps build a history of reliable payment behavior.
• Start with a Secured Credit Card: Get a credit card that is secured by a deposit you make to safely build credit as you spend within limits.
• Keep Low Balances: Only use a small part of your credit limit on each card. This shows you can manage credit well without relying too much on it.
• Be Patient: Understand that building good credit takes time. Focus on gradually improving your credit score for better future borrowing terms and opportunities.
• Monitor and Fix Your Credit Reports: Check your credit reports regularly and try to fix any errors. This will ensure your credit history is accurately represented.

Each of these strategies can yield positive results. Used together, they will likely help boost your credit score and eliminate the need for a cosigner.

3. Use Credit Builder Loans & Other Financial Tools

You should consider the following financial tools that will help you build credit. They can help you avoid using a cosigner, which may be what you prefer.

– Credit Builder Loans

A credit builder loan helps you establish or rebuild your credit. When you receive this type of loan, usually from a credit union, you don’t get the loan proceeds right away. Instead, the lender keeps the money in a special savings account while you make monthly payments on the loan. 

The lender reports these payments to the credit bureaus, which helps you build a good payment history. Once you’ve paid off the loan, you get all the money from the account. This process helps improve your credit and shows lenders that they can trust you to pay back the money you borrow.

– Consolidation Loans

Consolidation loans are useful if you have many debts because it allows you combine multiple debts into one loan. This means you only have one monthly payment instead of several. 

This type of loan typically has a lower interest rate than your original debts. With a lower interest rate, your payments may be smaller, and you can pay off the total debt faster.

This can help reduce your stress about managing multiple bills and improve your credit score by streamlining payments so you never miss a due date.

– Balance Transfers

Balance transfers are a popular way to manage credit card debt. You move what you owe from one or more credit cards to another card that has a lower, sometimes promotional, interest rate. By doing this, you pay less interest, which can save you money.

Paying less interest means you can pay more toward the principal you owe. This can help you pay off your debt faster. Quickly repaying your balance can improve your credit score because it shows you are good at managing debt.

– Credit Monitoring Services

A credit monitoring service keeps an eye on your credit reports for you. It notifies you of any changes, including new accounts opened in your name or changes to your credit score.

This can help you spot errors or signs of fraud quickly, which is important because fixing these issues can help keep your credit score healthy. 

By regularly checking your credit and addressing any problems right away, you can ensure the hard work you are doing isn’t undermined by fraud or erroneous information. 

– Credit Counseling

Credit counseling is a service that can assist you in navigating your debt and improving your money management skills. A credit counselor can help you create a realistic budget that fits your income and expenses. This makes it easier to manage your money effectively. 

Additionally, they can talk to your creditors and possibly get you lower interest rates or set up a payment plan that you can afford. These negotiations could make your monthly payments manageable, allowing you to consistently pay on time and gradually reduce your total debt.

Staying on top of your payments, sticking to a budget, and reducing your debt are key steps that can help improve your credit score.

Adding a cosigner to a loan or credit card is a big financial step. It means someone else, like a family member or friend, promises to pay the debt if you can’t. This can help you get credit that you might not get on your own.

You and the cosigner need to understand your responsibilities because cosigning ties your financial situations together. It can hurt both your credit scores if you don’t pay the loan on time.

Before you decide to use a cosigner, talk things over with them. Make sure you both know the plan, especially if it becomes difficult to make payments.

Remember, this decision impacts more than just your money; it can affect your relationship, too. Being clear and open about everything related to the loan can prevent problems later. It can also help both of you feel confident about agreeing to cosign.