The dangers of co-signed loans are plentiful for those signing on as the well-established borrower with good credit. However, co-signed loans can get just as sticky for primary borrowers down the line.
With so many risks involved with co-signing for both parties involved, borrowers should fully understand the repercussions of having someone co-sign their loans. The benefits might seem straightforward and ideal for the short term, but long-term financial goals can be negatively impacted by co-signed loans.
Building Credit With Co-Signed Loans
Before delving into why some lenders reject good credit built through co-signing, it's important to understand why anyone would choose this option in the first place.
Despite the tense balancing act that springs from co-singing, building credit with co-signed loans can be of immense help for borrowers who, under typical circumstances, would not qualify for a loan. Borrowers who benefit from soliciting a co-signer include:
- Individuals with little or no credit (e.g. young adults)
- Those with a poor credit history and credit score, hoping to rebuild their credit
- Borrowers with high debt-to-income (DTI) ratios (e.g. too many credit cards with high balances)
- Primary borrowers who are looking to make a purchase beyond their qualified loan amounts (e.g. more expensive home)
For these individuals, lenders might require that another person act as the co-signer, or guarantor, of the loan. In essence, the guarantor is guaranteeing that the primary borrower can and will keep in good standing with the lender by making timely repayments throughout the life of the loan.
If borrowers fail to fulfill the required payments for whatever reason -- unexpected unemployment, medical emergency expenses, divorce, etc. -- co-signers are held liable for the remaining debt owed.
Trouble arises, however, for borrowers who have only taken on co-signed credit and never financed anything on their own.
Dangers of Co-Signed Loans
Earning a great credit score over time through co-signing gives borrowers the confidence to take a financial leap by applying for a mortgage or auto loan individually. But tread this credit-building method carefully as it can have a negative impact on loan application results.
Getting short-changed with a high interest rate, or worse -- not getting approved for the loan completely -- is just one of the dangers of co-signed loans.
Lenders can remain hesitant to offer a new line of credit to consumers with a shallow credit history, like having a co-signed auto loan completed for a first car. A single auto loan backed by a co-signer does not give lenders the insight needed to deem the primary borrower trustworthy enough for new credit.
The possibility of having a loan rejected or receiving an unfavorable credit score should not deter consumers from improving their credit, however. There are viable loan alternatives that can put lenders' worries at ease and keep borrowers from relying on a co-signer's credit and good faith to obtain a loan.
Good Loans for Bad Credit
Those who suffer a poor credit score rating and were hoping to use a co-signed loan to rebuild their credit scores can still turn to other methods of borrowing to achieve a similar result.
A type of loan, called a secured loan, is an example of good loans for bad credit holders. Secured loans compromise with bad credit score holders by allowing borrowers to put forth an asset as collateral for a loan.
Collateral can include a big ticket item like a home or a car. Should a borrower be unable to repay the secured loan, the lender can legally take possession of the asset's collateral value to recoup the loss of the loan.
The collateral aspect of this loan type makes getting approved for a loan easier for those with a tarnished credit history. Moreover, borrowers can avoid the stigma of co-signed loans hovering over their credit reports.
When considering taking on a co-signed loan, giving long-term goals equal importance as short-term goals can help borrowers decipher whether co-signed loans are the best option for all parties involved.