A co-signer is someone who becomes responsible for a debt should the borrower default on it.
Unlike a co-borrower who is equally liable for the debt repayments, a co-signer is is under no obligation to make the monthly installment payments on a mortgage.
However, a lender will have the right to ask a co-signer to pay for what is due should the borrower be unable to repay the loan.
Co-signing as a guarantor is very commonly found in student loans.
This is because student who have yet to generate an income for themselves often don’t qualify for credit facilities like credit cards and personal loans.
This leaves them with little to no credit history for a lender to assess his or her creditworthiness.
A person (often a relative) with good credit and stable income would help alleviate the perceived risks of the lender and get the loan approved.
However the co-signer takes on a huge risk if the borrower fails to pay up in future.
This is why it is wise not to co-sign for anyone who you cannot trust 100%.
Problems with co-signing
It is understandable if it is a family member to be a co-signer for. But deciding to become one for someone unrelated should be seriously re-evaluated.
This is because it’s like getting onto a boat ready to sail off. Once you get on it, you can’t really get off it.
Technically speaking, a lender has the power to take a co-signer off a loan. But they have no incentive to do so.
Why would they voluntarily limit their options of redress?
But a co-signer might have walked into the contract thinking that his name could be removed from the loan once the borrower demonstrates an ability to repay.
This could be due to savvy sales talk or gross miscommunication.
The solution to this problem is to prevent it happening in the first place.
Another potential problem that a co-signer might not see coming is it’s future effects on his own loan applications.
Despite the efforts of government agencies and lenders to educate consumers of the existence of credit records and how it works, a lot of adults still do not know enough (if at all) about it.
And when they sign up as co-signers for a term loan or line of credit, they don’t know the implications of those actions and consequences they are getting themselves into.
One day in the future, they will only realize it after being turned down for a loan request for themselves.
Late payments made by the original borrower have caused their own credit scores to suffer.
And because they are also liable for the loan taken up by the borrower, the debt obligation associated with that loan has to be taken into account in the debt ratio.
For example, a borrower with a monthly income of $3,000 and monthly car loan payment of $300 would give him a debt ratio of 10%. Assuming a lender has credit policies in place to cap mortgage lender to 30% debt ratio, this leaves the borrower with an affordability of $600 a month. Assuming a mortgage at 5% over 25 years, it results in a loan amount of approximately $100,000.
However if he is co-signer of a study loan with a $250 payment each month, it will bring his debt ratio up to 18%, leaving him with $350 to pay for a house. Resulting in a loan amount of just around $60,000.
This affects the final approved loan amount and sometimes even the loan to value.
On top of that, borrowers who do not have good credit are often charged a higher interest rate by lenders compared to those who do.
In view of the potential problems mentioned above, anyone should think thrice before becoming a co-signer for someone as a favor.