What to Know Before Co-Signing a Personal Loan for Someone Else

What does co-signing mean?

By co-signing a personal loan, you agree to assume legal responsibility for the payment, if and when the original borrower fails to do so. Your income and credit history are taken into account by banks when approving a loan, as you become equally liable under the terms and conditions of the loan. (RBI circular on consumer credit usage)

How co-signing affects your credit

Your credit score may be affected by co-signing, since lateness shows up on the credit report and decreases the credit score.

1. The effects of payment history 

In case you miss payments, it will affect your credit score adversely.

2. Debt-to-Income Ratio 

The loan is going to increase your debt burden, which will affect your ability to get a home or additional financing.

3. Hard inquiry 

Lenders will conduct an adverse credit report on any co-signers and affect their scores adversely as well.

Risks of co-signing a loan

Before agreeing to provide financial assistance for someone else, understand the risks of co-signing a loan:

1. Legal liability 

The collections and outstanding debts may result in legal action against you.

2. Collections and wage garnishment 

Your assets or income may be garnished depending on the terms of your contract.

3. Long-term credit impairment

A default will impair your credit score for a long time because of bad credit marks.

Before you agree: six checks to perform

Examine the document, investigate the borrower's financial situation, and thoroughly confirm the lender's reputation before signing. 

1. Review your loan agreement

Collect the loan document and familiarize yourself with the interest rate, loan term, prepayment penalties, and consequences in case of non-payment of the loan.

2. Examine the borrower's repayment schedule

Ask the borrower to provide a realistic budget and backup plan.

3. Weigh the reputation of the lender

Before lending to a borrower, examine lending institutions, fees, and borrower ratings on comparison websites like RupeeOnTime.

4. Analyze your finances

Are you struggling financially to pay off your loan? Find out what the worst-case scenario would be.

5. Investigate the credit report

Ensure that the loan is recorded by credit bureaus; otherwise, you may still be legally liable and not able to enjoy the benefits of credit if paid off regularly.

6. Find out any possibility of release

Some lenders release a co-signer after some time of regular payments; ensure that this is documented in writing.

Alternatives to co-signing

Instead of co-signing, consider these safer options:

1. Rather than co-signing, you can offer cash or loan funds directly to the borrower with clear repayment conditions.

2. Offer a loan instead of being a co-signer secured by collateral that you both agree on.

3. Suggest the borrower open an account on a small personal loan, a secured credit card or a credit builder product in their name.

4. Credit card accounts may add individuals as authorized users in order to build credit while preventing legal liability.

How to protect yourself if you co-sign

Even though one cannot avoid all risks entirely, here are some of the ways that may help to reduce any financial risk that may arise.

1. Make sure the loan agreement is documented

Work with the borrower to draft a personal contract with the details of the agreement.

2. Document all dealings

Always keep documents of your correspondence, loan details, and payment records.

3. Monitor the loan

Ensure to check your credit history regularly in case there are any mistakes and delinquencies.

4. Make automatic transfers

Ensure to set up automatic transfers in case you will be helping out in making the payments.

Key takeaways

By co-signing a personal loan, you assume legal and credit responsibility. Co-signing a loan involves significant risks such as strained relationships, potential lawsuits, and harm to credit. Prior to finalizing an agreement, utilize Rupee On Time to assess lenders and understand loan conditions.