When you’ve worked hard to build good credit, at some point a family member or a friend may ask you to cosign on a loan. They may be having trouble establishing credit on their own, and they may not be able to get approved without a cosigner. Even though you’d like to help them out, before you agree to cosign, consider the dangers of cosigning on a loan.
What Happens When You Cosign?
If you agree to cosign on a loan, your loved one may be able to get approved because of your good credit history. Since you’ve been careful with your finances, they are no longer considered a risky borrower on the loan you’ve cosigned. While you’ve made it possible for them to be approved, you may have made your own financial situation more unstable because you’re promising to cover their debt if they don’t make their payments.
How Your Credit is Affected
Besides taking the risk of having to make the payments yourself, becoming a cosigner may harm your credit score. The hard inquiry done by the lender before opening the loan can cause a slight dip in your credit score. Once the loan shows on your credit report, your debt-to-income ratio increases. This could make it difficult for you to obtain new credit for yourself.
If the person who asked for this favor is unable to pay the loan, your relationship may be damaged. It can be especially harmful if they aren’t honest with you about their financial distress, and you don’t discover the problem until payments are missed. Your budget may be strained if you try to make the payments yourself, and you may have a hard time trusting that person in the future, putting further strain on the relationship.
Think Through Agreeing to Cosign
Deciding to cosign someone else’s loan is something you should consider carefully. Going through with it threatens your credit, clouds your overall financial picture and could eventually destroy your relationship with your friend or loved one. There are other options you may want to suggest, such as a secured credit card or a credit builder loan.
Before taking on the responsibility of cosigning a loan, consider your debt to income ratio. You may decide it’s worth the risk in certain circumstances, such as cosigning with one of your children for a student loan or their first car. It may be less harmful to you if you aren’t planning to borrow money in the near future.
Watch Your Credit
Before even considering a loan, it’s always a good idea to pay attention to what’s being reported on your credit report. Errors on credit reports are surprisingly common. If you find an error, Dovly can help you dispute it. Dovly is an AI credit engine that can help you track and fix your credit. Try it risk-free with our free membership tier. Contact Dovly today.