Co-signing a loan is a significant financial decision that can help a friend or family member secure financing, but it also comes with a serious set of risks and responsibilities.

If you’re considering co-signing a loan, it’s crucial to understand what you’re getting into. In the simplest terms, co-signing means you’re agreeing to take on the responsibility of someone else’s loan if they can’t make the repayments. It’s a generous act, but it comes with potential hazards.

So whether you’re thinking about co-signing a loan or just curious about the process, keep reading to get a better understanding of what’s involved.

• What is co-signing?
• Benefits of co-signing a loan
• Risks of co-signing a loan
• Alternatives to co-signing
• Protecting your credit when co-signing
• Building credit through co-signing
• FAQs about co-signing a loan

What is co-signing?

Co-signing a loan is a commitment that should not be taken lightly. It involves agreeing to take on the responsibility of a loan if the primary borrower cannot make the repayments.

Defining co-signing and its purpose

Co-signing is a practice used by lenders to help secure loans for people who may not have a strong credit history or sufficient income. By having a co-signer with a good credit score and steady income, the lender more confidence that the loan will be repaid, even if the primary borrower defaults. 

This can benefit the borrower, who may be able to secure a loan with better terms than they would otherwise qualify for.

As a co-signer, you’re essentially vouching for the borrower’s ability to repay the loan, and if they fail to do so, you’re on the hook to pay.

Co-signing vs. joint loans

Co-signing a loan is not the same as having a joint loan. In a joint loan, both parties are primary borrowers and share equal responsibility for the loan from the start. They both have equal rights to the property or item purchased with the loan and are equally affected by the loan’s impact on their credit scores.

In contrast, a co-signer only becomes responsible for the loan if the primary borrower defaults. The co-signer does not have any ownership rights to the property or item purchased with the loan, but their credit scores can be affected if the primary borrower fails to make payments.

Typical scenarios for co-signing

Co-signing is often considered in situations where the primary borrower is a student with no credit history applying for a student loan or a first-time car buyer who needs an auto loan but lacks a credit history. 

It can also be a consideration when someone is trying to rebuild their credit after a financial setback, such as bankruptcy or foreclosure. In these scenarios, having a co-signer can make the difference between being approved or denied for a loan.

Benefits of co-signing a loan

Co-signing a loan allows you to help someone secure a loan that they may not have been able to obtain on their own. 

Additionally, if the borrower makes their payments on time, it can help both parties build a positive credit history. This can be particularly helpful for the primary borrower, who may be trying to establish or rebuild their credit. 

For the co-signer, it can provide a sense of satisfaction in helping someone they care about achieve their financial goals.

Risks of co-signing a loan

Co-signing a loan comes with significant risks. As a co-signer, you’re legally responsible for the loan if the primary borrower can’t make the repayments. This can affect your credit scores, increase your debt-to-income ratio and potentially lead to legal action if the loan isn’t repaid.

It’s also important to note that as a co-signer, your credit could be affected even if the primary borrower makes all their payments on time. That’s because the amount of the loan is considered part of your overall debt, which can affect your credit utilization ratio and potentially lower your credit scores.

Alternatives to co-signing

Before agreeing to co-sign a loan, you may want to consider other options. For example, the borrower could apply for a secured loan or a credit-builder loan, which may be easier to obtain and carry less risk for you.

A secured loan requires collateral, such as a car or house, which reduces the risk for the lender and can make it easier for the borrower to get approved. 

A credit-builder loan, on the other hand, allows the borrower to make payments to a savings account for a set period of time, and then gives them the money once they’ve completed all the payments. This can be a good way for someone with poor or no credit to build a positive credit history. You might also want to consider Credit Karma’s Credit Builder plan, which can help you build low credit while you save.

Protecting your credit when co-signing

If you decide to co-sign a loan, it’s important to take steps to protect your credit. This could include setting up online account access to monitor the loan, arranging for the lender to notify you if payments are overdue, and setting aside money to cover any missed payments.

It’s also a good idea to have a candid discussion with the primary borrower about the importance of making their payments on time and the potential consequences if they fall behind on their payments.

Building credit through co-signing

While co-signing a loan can help your friend or family member build credit, it’s important to remember that this shouldn’t be the sole reason for co-signing. The risks associated with co-signing a loan can outweigh the potential benefits to the primary borrower.

Next steps

Before co-signing a loan, it’s crucial to fully understand the risks and responsibilities involved. 

If you’re still on the fence, remember that co-signing a loan is a significant commitment that can have long-term effects on your financial health. Before you act, you might consider reaching out to a financial advisor who can provide personalized advice based on your financial situation.

And don’t forget to explore alternatives to co-signing, such as secured or credit-builder loans. Learning more about managing your money can help you make decisions that benefit your long-term financial health.

FAQs about co-signing a loan

*Approval Odds are not a guarantee of approval. Credit Karma determines Approval Odds by comparing your credit profile to other Credit Karma members who were approved for the personal loan, or whether you meet certain criteria determined by the lender. Of course, there’s no such thing as a sure thing, but knowing your Approval Odds may help you narrow down your choices. For example, you may not be approved because you don’t meet the lender’s “ability to pay standard” after they verify your income and employment; or, you already have the maximum number of accounts with that specific lender.

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Are you trapped in a debt spiral of mounting credit card debt, high interest rates and a minimum monthly payment that’s becoming difficult to meet?

If you are, you might be feeling frightened or overwhelmed. But your credit card company likely offers an unadvertised program that could make all the difference.

A hardship plan, also known as a credit card payment plan, is a well-kept secret that has the potential to save you big bucks in interest, reduce your monthly financial burden and finally let you break free of your debt spiral.

Think a payment plan might be right for your financial situation? Let’s dive in to what a hardship plan is (and isn’t) and how it might impact your credit in unexpected ways.

• What is a hardship plan?
• Possible downsides of a hardship plan
• How could your credit improve?

What is a hardship plan?

A hardship plan is not the same as the debt management plans you see advertised on TV.

With a debt management plan, you work with a credit counselor who acts as the liaison between you and all your unsecured debt creditors. Typically for a fee, the counseling agency analyzes your income and spending, negotiates debt repayment terms with each of your lenders and pays all of them with a single monthly payment it collects from you.

With a hardship plan, however, there’s no intermediary and no mass payment of lenders. Instead, you work directly with your credit card issuer and participate in its unique repayment program. Many creditors do offer hardship plans, though you’ll rarely find them advertised.

“Each creditor’s policy is a little bit different,” says Thomas Nitzsche, credit educator and communications lead at Clearpoint, a nonprofit credit counseling agency. He notes that plans typically offer a combination of the following benefits:

• A lower interest rate
• A smaller minimum payment
• Lower fees and penalties
• A fixed payment schedule

When you’re facing a temporary financial rough patch — a recent job loss, medical emergency or serious accident, for example — Nitzsche says that calling your creditor and telling your story may persuade the company to offer you the money-saving perks of a payment plan.

Possible downsides of a hardship plan

The act itself of signing up for a hardship plan has no effect on your credit. However, once you enroll, your credit scores could be indirectly affected because of the way the program works.

First, your credit card issuer may put a note on your credit reports regarding your participation in its hardship plan. So while the note signals that you’re taking positive steps to responsibly repay your lenders, it could make potential creditors nervous about your financial situation. Before you sign up for a payment plan, talk with your issuer about what note (if any) will be sent to the credit bureaus.

Second, while you’re participating in a hardship program, your card company may close or suspend your account until your payment schedule is complete. And closing a credit card — whether you do it yourself or your card company does it for you — can hurt your credit scores by affecting a few different things:

• Credit utilization ratio: Your credit utilization ratio represents the portion of your available credit that you actually use, and it accounts for a whopping 30 percent of your FICO® score. In general, your scores can increase as you use less of your total credit limit. So, when you shut down a card, you eliminate some of that available credit. And if you don’t decrease your credit card spending, your scores will drop to reflect the increase in your utilization ratio.
• Length of credit history: Your credit scores reward you for having mature lines of credit. In fact, 15 percent of your FICO® score depends upon the length of your credit history. So if your creditor closes one of your older cards when putting you on a payment plan, your average credit age will decrease, and your scores could go down as a result.
• Credit mix: FICO® rewards you for having a desirable combination of credit cards, mortgages, car payments and other types of loans. This combination — or credit mix — makes up about 10 percent of your FICO® score. When you close a card, your credit mixture changes, and that could affect your scores.

That said, participating in a hardship plan could actually benefit your credit scores in the long run.

How could your credit improve?

After you sign up for a hardship plan, you might see a concerning dip in your credit scores. This typically isn’t permanent, though it could take months of on-time payments and responsible behavior to get your credit back to where you’d like it.

If you successfully complete your program, that initial dip could transform into a sizable credit score increase. Here’s why:

If you’re thinking about signing up for a hardship program, you may have already missed some minimum payments on one or more of your cards. Payment history is the No. 1 factor in determining your FICO® score, making up 35 percent of the score. So you may have already seen your credit scores decline after missing payments.

Fortunately, sticking to a hardship plan’s payment schedule is an excellent way to rebuild your history of timely debt repayment. Your lender, who reported those late payments to the credit bureaus, will now report your consistent, on-time payments — which can mean good news for your scores.

Bottom line

So, is a hardship plan right for you?

They’re not right for everybody, Nitzsche says.

“If you’re somebody who struggles with being organized, if you have multiple creditors, if you’re intimidated by contacting all of them directly, or if the thought of managing all those individual payments each month is daunting,” he says, “it might behoove you to see a credit counselor and consider debt management.”

Just be aware that dealing with debt settlement companies can be risky, according to the Consumer Financial Protection Bureau, and might leave you deeper in debt than when you started. The CFPB recommends seeking out a nonprofit consumer credit counseling service as an alternative or speaking with a bankruptcy attorney if you’re considering that route.

If, however, you’re facing a temporary financial crisis or a relatively minor problem with just a few cards, your card issuer may be willing to extend concessions when it comes to repaying. So pick up the phone, call up your creditor and make your case. It could be the turning point in conquering your credit card debt.