Melanated Mogul

Have you ever been asked to co-sign a loan or an apartment lease for a friend or family member? Maybe you’re considering asking someone to co-sign for you. What does co-signing actually entail, and what are the risks and benefits? In this blog, we’ll dive into the details of co-signing, including the pros and cons, why people need co-signers, and how to establish financial independence to avoid needing a co-signer. We’ll also provide tips for financial fitness to help you make informed decisions about co-signing.

What is Co-Signing?

Co-signing means that you agree to take on the financial responsibility of a loan, lease, or credit application if the primary borrower fails to meet their obligations. Essentially, you’re guaranteeing that the debt will be repaid, even if the borrower defaults. This can be a significant commitment, and it’s essential to understand all the implications before agreeing to co-sign for someone.

Why People Need Co-Signers

Individuals often need co-signers for various reasons:

• Lack of Credit History: Young adults or new immigrants might not have a sufficient credit history to qualify for a loan or lease on their own. According to Experian, about 26% of adults aged 18 to 24 lack a credit score altogether (Experian, 2021).
• Poor Credit Score: Those with a low credit score may require a co-signer to reassure lenders or landlords that the debt will be paid. Approximately 30% of Americans have a credit score below 601, classifying them as having poor credit (FICO, 2022).
• Income Requirements: Sometimes, the primary borrower’s income might not meet the lender’s or landlord’s requirements, necessitating a co-signer. According to the Federal Reserve, around 20% of loan applicants were denied credit due to insufficient income in 2020 (Federal Reserve, 2021).

According to financial expert David Ramsey, “Co-signing is needed when someone doesn’t qualify for a loan or lease on their own. It’s a way to leverage another person’s creditworthiness to secure financial agreements” (Ramsey, 2023).

The Pros and Cons of Co-Signing

Pros

• Helping Loved Ones: Co-signing can help a friend or family member secure necessary housing or credit.
• Building Credit: If the primary borrower makes timely payments, it can positively impact both parties’ credit scores.

Cons

• Financial Risk: If the primary borrower defaults, the co-signer is responsible for the debt.
• Credit Impact: Any late payments or defaults will negatively impact the co-signer’s credit score.
• Strained Relationships: Financial disagreements or defaults can strain personal relationships.

Examples of Co-Signing Situations

1. Student Loans: Parents often co-sign student loans for their children to help them afford higher education. A study by the Consumer Financial Protection Bureau found that 90% of private student loans were co-signed in 2019 (CFPB, 2020).
2. Auto Loans: A person with a low credit score might need a co-signer to purchase a vehicle. About 60% of auto loans for borrowers under 25 require a co-signer (Experian, 2022).
3. Rental Applications: Young adults without a rental history might require a co-signer to secure an apartment lease. Approximately 30% of first-time renters need a co-signer (Zillow, 2021).

Risks to Co-Signers

Co-signing can be risky. According to a report by the Consumer Financial Protection Bureau (CFPB), co-signers are liable for the full amount of the loan and any associated fees if the primary borrower defaults (CFPB, 2022). This can lead to legal action, wage garnishment, or asset seizure. Additionally, co-signing can limit your borrowing capacity since the co-signed debt counts towards your total debt load.

The likelihood of default is also significant. For instance, data shows that about 38% of co-signed loans end up in default, putting co-signers at considerable financial risk (CFPB, 2020).

Establishing Financial Independence

To avoid needing a co-signer, it’s crucial to build a solid financial foundation:

• Build Credit Early: Start building credit by using a secured credit card or becoming an authorized user on a family member’s card.
• Maintain a Good Credit Score: Pay your bills on time, keep your credit utilization low, and avoid opening too many new accounts.
• Increase Your Income: Boost your income through side jobs or furthering your education to meet lenders’ requirements.

Tips for Financial Fitness

1. Create a Budget: Track your income and expenses to manage your finances effectively.
2. Save Regularly: Build an emergency fund to cover unexpected expenses and avoid debt.
3. Educate Yourself: Take advantage of financial literacy resources to understand credit, loans, and personal finance better.

Get Help from Smart Finance Partners

Smart Finance Partners can help you with financial literacy, credit-building, budgeting, credit monitoring, credit restoration, and more. Through our partnership with United Credit Education Services, at times, we offer core financial products and services at a discounted membership rate for ongoing access. To get these discounted services, just email us at DrADawson@melanatedmogul.blog. You can also find more information and resources on our Linktree.

When to Avoid Co-Signing

Avoid co-signing if:

• You cannot afford to take on the debt.
• The borrower has a history of financial irresponsibility.
• The agreement would strain your relationship with the borrower.

Conclusion

Co-signing can be a helpful tool but comes with significant risks. It’s essential to weigh the pros and cons, understand your responsibilities, and consider your financial situation before agreeing to co-sign. Building a strong financial foundation can help you avoid needing a co-signer and make informed decisions about your financial future. By following the tips for financial fitness and literacy, you can ensure that you’re prepared for any financial challenges that come your way.

Remember, co-signing is not just a financial decision but a personal one, and it’s crucial to be fully informed and prepared before making that commitment.

References

Consumer Financial Protection Bureau. (2020). Private student loans. Retrieved from https://www.consumerfinance.gov/

Consumer Financial Protection Bureau. (2022). What you need to know about co-signing a loan. Retrieved from https://www.consumerfinance.gov/

Experian. (2021). Credit invisibles: Are you one of the 26 million Americans with no credit history? Retrieved from https://www.experian.com/

Experian. (2022). State of the automotive finance market: Q1 2022. Retrieved from https://www.experian.com/

Federal Reserve. (2021). Report on the economic well-being of U.S. households in 2020. Retrieved from https://www.federalreserve.gov/

FICO. (2022). Credit score distribution. Retrieved from https://www.fico.com/

Ramsey, D. (2023). The truth about co-signing. Retrieved from https://www.daveramsey.com/

Zillow. (2021). Zillow rental trends report. Retrieved from https://www.zillow.com/