By co-signing, you help someone get a loan. However, you must realize that it has repercussions, both good and bad.
Co-signing is a goodwill gesture to help someone with poor credit history, to obtain a personal loan, by accepting to share the liability on documents. Of course, co-signing does not mean that you will pay the loan. However, it definitely entitles the bank to recover the loan from you in case the main applicant fails to pay up.
Co-signing is often done for a family member, a friend, a colleague or business partners, in order to help them during their crucial times. Indirectly, you may be helping a sick person to get treatment, a child with his education or a daughter to visit her ailing parents. By co-signing their loan, you are reducing their burden as the interests charged on co-signed loans could be lower.
However, one must realize that by lending our good reputation to our friend, we are sharing the liability equally with them. It is as good as taking a loan for ourselves.
How does co-signing impact your credit report?
When you co-sign a loan, it is shown in the credit report of both the applicants. It does not immediately increase your debt, but it surely has repercussions, both good and bad. The effects of co-signing vary with the type of loan and loan amount you are co-signing.
Not everything is risky when it comes to co-signing. You may be surprised to know there are some benefits from it:
# Regular payment of loans increases your credit scores. Imagine, you co-signed a personal loan for a friend, who has never missed a payment. This has a huge positive impact on your credit score.
# Your improved credit scores will increase your chances of getting a loan for yourself in the future.
# Promotes healthy relationship with the financial institution.
# Gives you a sense of satisfaction of having fulfilled someone’s needs.
Once you decide to co-sign for a needy person, all goes well as long as the main applicant makes timely payments. However, you become obligated to repay the debt if he/she fails to pay and the lender looks upon you for repayments.
Here are some risks involved in co-signing which vary in levels and urgency:
# While the co-applicant enjoys the rewards of the loan amount, all you get is liability on your shoulders.
# Be prepared to face legal complications if the primary applicant turns a defaulter.
# Risk the chances of getting your loan approved if the above happens.
# Ultimately, it is YOU who must make the payment in worst case scenario and ‘be prepared’ for this.
Impact on Revolving Utilization
Revolving utilization is the ratio of how much outstanding credit balance you have against your available credit limit. It is also known as the ‘debt-to-limit’ ratio and is one of the major factors that influences one’s credit report. If your friend (the main applicant) has large balances on credit card, then the debt in turn will impact your ‘revolving utilization’ and pull down your credit score.
It is very important to understand the participation of both applicants in co-signing. Even if you are co-signing to help your friend with your good credit, the same may not be the case if he/she fails to pay. That loan will be shown on your credit history as well. It is a good idea to check the loan status once in a while, to avoid having to pay a large amount at once. It is best advised to co-sign only with the friends and relatives you trust the most.
Factors you must consider before co-signing
Imagine you are co-signing a personal loan with your friend Amit. Do remember to check a few things, before you commit.
# Keep emotions apart and think whether you can repay the loan in full if Amit fails to do so.
# Have an open communication with Amit about his repayment strategy.
# Obtain transparency in the transaction, both with Amit and the bank.
# Always have a Plan-B.
# Check if Amit has a positive bank balance or has enough assets to repay the loan.
# If he is a business owner, check his balance sheet to get a perspective on his financials.
# Hope for the best, but prepare for the worst!
(By Aditya Kumar, Founder & CEO, Qbera.com)