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Cosigning a loan is not uncommon in the current financial climate. People cosign a loan for their family members, siblings, children, friends and others. Helping someone get an approval on their loan application just by cosigning can feel like a rewarding experience. But, it does not come without its risks.
Before you cosign a mortgage for someone, there are various things you need to consider, including how cosigning a loan will affect your own finances.
But first-
In a standard situation when a person decided to apply for a Personal Loan, or any other loan for that matter, there is an agreement between the borrower and the lender stating the terms of the loan. In the case of a cosigner, the agreement is also signed by a third person, the cosigner.
Having a cosigner is essentially like an insurance for the lender because by signing the document, the cosigner is agreeing to pay the loan in case the borrower fails to do so. The cosigner is equally responsible for the loan even if they’re not the one responsible for the EMI payments.
Now that we know what cosigning a loan means, let us see what important questions to ask before cosigning a loan:
Someone would ask you to cosign a loan in the first place when they can’t get credit on their own. This can be due to various reasons, including their bad credit score, past loan default, or missed EMIs. However, this can also be because someone, like your children, are new to credit, and they have never taken a loan or credit card before. The lack of credit history for a new to credit person will make it very difficult for them to get a loan, which is why they need you to cosign their loan application.
Cosigning a loan essentially means that you are as responsible for the loan as the borrower. If the borrower is late on his EMI payments, it will affect your credit score. If the borrower defaults on the loan, it will fall upon you to repay the loan, and if you can’t then your credit score will be severely affected. Cosigning a loan is a big responsibility, especially when you consider the effect it can have on your credit score.
On your credit report, it will also add to your debt. This will affect your debt-to-income ratio, and adding more debt can bring down your credit score by itself. However, what is also to consider that if the loan is paid back in time, without any missed payment, it will add positively to your credit score.
Remember: It is important to keep an eye on your credit score, especially if you have cosigned a loan. You should check your free credit report online every few months and ensure that everything stays on track.
Here are a few downsides of cosigning a loan that you should keep in mind:
You can’t ever be fully safe when cosigning a loan. However, you can take certain precautions and mitigate your risk:
Thus, make sure you know what you’re getting into. The decision to help out someone to get a Personal Loan or any other loan, should not be taken lightly. This is a decision that will affect your life positively or negatively.
Which is why it is always a great idea to take the necessary steps to ensure that you safeguard not only your credit scores but also your own finances.