Has a family member ever asked you to lend them money? While it might not seem so at first, co-signing a loan or other financial agreement is quite similar. And in many ways, it can be even riskier.
Whether for a credit card, mortgage, apartment lease, or a new car, co-signing is a meaningful way to support those you love, but it comes with financial consequences. Equally important to the financial considerations are the potential effects co-signing can have on your relationship with a loved one, for better or worse.
While helping your adult children or close family members get on their feet is one of the most meaningful ways to provide support, it’s important to think through what that may look like. We consulted with a Chartered Property Casualty Underwriter (CPCU) insurance specialist to help us further understand what you should know before co-signing.
How Co-Signing Affects Your Financial Life
When agreeing to co-sign a loan or agreement, your financial picture will be immediately impacted, regardless of whether it’s a personal loan, car loan, student loan, house mortgage, credit card, or other financial obligation.
For loans in particular, lenders will often run a hard inquiry on your credit score before determining whether to approve the loan. Some landlords or leasing offices will run these hard inquiries as well. While a hard inquiry typically only decreases your credit score by a few points, it can be an issue if you recently took on a loan (or plan to in the near future). Multiple inquiries within a small time frame often raise lender concerns, making it harder to be approved. On the other hand, co-signing can actually improve your credit score over time if timely loan repayments are made.
Once you co-sign on a loan or line of credit, it will be added to your credit report and appear as your debt. Similar to having multiple hard inquiries, additional debt may also impact your ability to qualify for loans.
Finally, and perhaps most significantly, by co-signing, you assume the legal responsibility to take on your loved one’s debt or financial obligations in the event they’re unable to pay. If you co-sign on a college-age child’s lease agreement, for example, you’ll be held financially responsible in the event they damage the property or can no longer pay rent on their own. Given you may not just be liable for payments, but also damages, review the lease and guaranty language carefully: If it includes “joint and several liability” or specifies responsibility for “all obligations,” the co-signer is likely on the hook beyond just payment delinquencies. And it may also mean being on the hook for issues arising from any roommate damages and delinquencies. This is where having proper insurance coverage can bring huge peace of mind.
Why a Co-Signer Is Sometimes Necessary
In some cases, having a co-signer can be the only way for someone to qualify for a loan or lease, especially if they’re just starting out on their credit journey. Lenders and landlords are primarily concerned with the risk they take on by trusting an inexperienced borrower—or someone with a history of poor credit performance. They want confidence that the borrower or tenant can make payments on time and in full. When that confidence is missing, a co-signer with stronger financial credentials can make all the difference.
Here are a few other reasons why a cosigner may be required:
Insufficient Income
One of the most common reasons a co-signer is needed is insufficient income.
Say your adult child is in their first year out of college, working an entry-level role. As a full-time student, they may not have a high enough income to qualify for certain loans (like a car loan) or for a housing lease. And when it comes to a mortgage, income directly affects how much house they can be preapproved for. Your additional income can help increase their chances of loan approval and the amount they’re eligible to borrow.
Lack of Credit History
Young adults tend to have little in the way of a credit history (or any history at all). When this is the case, lenders and leasing offices lack any sort of basis for approval. Without a credit history, your loved one may have a hard time qualifying for certain loans or other financial agreements. If they do qualify, they’ll likely be subject to a higher interest rate or low credit limit.
High Debt-to-Income Ratio
Debt-to-income (DTI) ratio is another key factor in determining loan eligibility. If your loved one has a high DTI, this signals to lenders that a significant amount of their earnings are already committed to existing debt, making them a riskier candidate for taking on additional payments. If you have a lower DTI, you can help reduce the combined ratio and make their application more attractive to lenders.
Desire for Better Loan Terms
Having a cosigner can often unlock more favorable loan terms, such as a lower interest rate or more flexible repayment options.
4 Questions to Ask Yourself
Before co-signing for a family member, consider the following questions. Your answers to the questions below will help you be mindful and pragmatic as you make a decision.
Question #1: How Will I Be Notified if There’s a Payment Issue?
Think through the worst-case scenario: The person you cosigned for can’t make their payments, and now the responsibility falls on you. When this happens, it’s important to know what the course of action will be. Is your relationship close enough that they’ll feel comfortable letting you know?
Lenders and landlords don’t always notify the cosigner of issues before charging late fees, (eventually) sending them to collections, or taking legal action (like eviction). On top of your credit score being affected, you could also become responsible for missed payments without warning.
Question #2: Do I Trust My Child to Handle This Financial Agreement Responsibly?
While it can be challenging to look at your child’s ability to be a responsible borrower in an objective way, it should be part of the decision-making process. Are they prepared to repay the loan or cover rent each month? Do they have the means to do so?
Ask yourself also, will doing this impact your relationship? In other words, are they comfortable having you involved in their financial affairs, and will you still be able to foster their independence while being involved in this way?
Consider whether or not challenges such as a missed payment or blurred personal boundaries could create tension in your relationship. You’ll need to be willing to navigate a possible shift in your dynamic.
Question #3: Am I Prepared to Repay This Loan Myself?
As a cosigner, you’re essentially agreeing to take on the financial responsibility of whatever agreement you sign alongside your child or loved one. While you hope that never has to happen, legally, it can become your responsibility.
If this financial obligation does fall on your shoulders, how will it impact your financial life? Will it halt progress on your savings goals? Require you to pull from investments or savings? Impact your ability to retire? When you say yes to cosigning for a loved one, treat it the same as if you’re taking on the debt or lease yourself, because depending on their ability to pay, that could be the case.
Our insurance specialist recommends that “if the parent is on the lease, they should have a conversation with their insurance agent about extending liability from their primary residence and umbrella policy to the rental location. The additional cost is minimal, and they are provided with liability coverage and legal defense.” He also suggests the child get a renters policy in their name with at least $1 million in Personal Liability coverage. “If there are roommates, I’d advise each roommate to get their own policy.”
Question #4: Am I Okay With Adding This Expense to My Financial Picture?
Not only will a hard inquiry on your credit report impact your credit score, but the debt itself will also show up on your credit report once the loan is finalized. As a result, your debt-to-income ratio increases, which can affect your ability to qualify for new loans.
Consider whether or not this will affect your own goals. If you have plans to buy a house or open up your own line of credit, you will have to determine whether or not it’s worth potentially jeopardizing your own loan approval.
Our insurance guru says, “in terms of co-signing for a vehicle, sometimes the parent’s name is not only on the loan, but the title and registration.” This level of ownership adds another exposure for the parents. “If parents technically own the car, the auto policy should list them as a named insured and vehicle added to umbrella. This extra insurance coverage could be another unexpected cost of co-signing.”
If you’re not planning on taking additional loans anytime soon, adding the debt to your financial standing may not have an immediate impact. Either way, it’s still important to consider both your short-term and long-term goals.
Making the Right Decision Starts with Honest Reflection
In many scenarios, enlisting the help of a co-signer can be a reasonable request. But if you’re being asked to co-sign, it’s important to consider the context. It’s one thing if your recently graduated child asks you to co-sign so they can build credit and establish financial independence. It’s another if a financially independent adult is asking you to co-sign due to a history of poor credit.
By understanding the ‘why’ behind the request, looking closely at your own goals, and reflecting on your relationship with your family member, you can assess the risk and decide whether co-signing is truly the right choice.
If you’re considering co-signing a loan or agreement but are feeling unsure, get in touch with our team today. We are here to help you navigate financial crossroads while keeping your goals first.
