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.

Related Articles
  1. Budgeting

    Key Questions to Ask Before Moving in Together

    Moving in together is a big step. Here are some key financial questions to ask your partner before you make the move.
  2. Credit & Loans

    10 Ways Student Debt Can Destroy Your Life

    If you're getting a student loan, think critically about how you will manage your loan. Student debt could have a profound negative impact on your life.
  3. Credit & Loans

    Your Credit Score: More Important Than You Know

    Credit scores affect key aspects of your personal and professional life. Knowing your score and managing your credit input can make a big difference.
  4. Credit & Loans

    Bad Credit? You Can Still Get a Home Equity Loan

    If your credit history is less than stellar and you need cash, you may be able to get financing – but it will come at a price.
  5. Credit & Loans

    Does a Lost or Stolen Credit Card Hurt Your Credit Score?

    Learn the ways in which a lost or stolen credit card can hurt your credit, and understand the steps you can take to protect yourself if this happens.
  6. Credit & Loans

    Refinancing vs. a Home-Equity Loan: How to Decide

    If you want to pay off debt, make home improvements or just get a better interest rate, you need to know exactly what these terms mean.
  7. Credit & Loans

    Millennials Guide: How to Pick the Right Mortgage

    Here’s help in finding the perfect, affordable loan for that home you have been dreaming about.
  8. Credit & Loans

    How Regulations Protect Reverse Mortgage Borrowers

    They're complex animals, which is why there are government guidelines in place to protect borrowers.
  9. Credit & Loans

    Millennials Guide: Buying Your First House

    Millennial homebuyers need to research a lot of things, such as how much to pay, down payments, PMI, FHA loans and special programs for first-time buyers.
  10. Budgeting

    The 7 Best Ways to Get Out of Debt

    Obtain information on how to put together and execute a plan to get out of debt, including the various steps and methods people use to become debt-free.
  1. Will my credit score suffer from debt consolidation or refinancing?

    You have several options for reducing your debt burden. You can enroll in a professional debt management plan, or consider ... Read Full Answer >>
  2. Can I file for bankruptcy more than once?

    Filing bankruptcy is never a simple decision, but sometimes it is the best thing you can do in your current financial situation. ... Read Full Answer >>
  3. Why would someone change their Social Security number?

    In general, the Social Security Administration, or SSA, does not encourage citizens to change their Social Security numbers, ... Read Full Answer >>
  4. What types of liens are seen as good and which are bad for my credit?

    Creditors that allow purchases to be made through financing often require property to be pledged against a credit account; ... Read Full Answer >>
  5. What are the typical requirements to qualify for closed end credit?

    Typical requirements for a consumer to qualify for closed-end credit include satisfactory income level and credit history, ... Read Full Answer >>
  6. What is the best way to start to rebuild your credit after a bankruptcy?

    Bankruptcies can be devastating to your credit score. Even worse, a bankruptcy will be listed on your credit report for between ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!