If you need a personal loan, you may be able to get it even if you don't have strong credit. The catch? You'll probably need to find someone with strong income and an excellent credit score and ask them to co-sign the loan with you. And you need to find a personal loan lender willing to accept co-signers.
What Is a Co-signer?
A co-signer is an individual who can personally guarantee a loan with their own credit and income level to help another person -- usually a family member or friend -- who isn't able to take out the loan because of a less-than-sterling credit rating or income level.
"(For a co-signer,) it is a way to extend your own good credit for the betterment of people you're trying to help," says Michael Emancipator, assistant vice president and regulatory counsel for the Independent Community Bankers of America. This isn't just a "put in a good word for me" gesture -- the co-signer must be ready to step in and make monthly payments if needed. During the underwriting process, "the bank has to envision the co-signer as the sole source of payment," he says.
[Read: The Best Personal Loans.]
Why Would You Need a Loan Co-signer?
Co-sign arrangements are common for people who need a personal loan and don't have much -- if any -- credit history. For example, parents can co-sign a loan for a child who is a recent college graduate.
A 2017 Consumer Financial Protection Bureau study of people who were "credit invisible," which the bureau defined as having no record with the three credit reporting agencies, showed about one-third of personal loans were opened with a co-signer. The amount was highest for borrowers ages 65 to 69 at 37.9 percent, those younger than 25 at 36.7 percent, and those 60 to 64 years old at 36.3 percent.
However, credit history could be just one of the reasons a lender might not approve your personal loan, says Matt Dworetsky, Dworetsky Financial retirement planning specialist. A would-be borrower with low income (maybe due to a job loss) or with credit and income problems (perhaps after a divorce) could make lenders think twice. A co-signer could help that person get through a difficult financial time.
Primary borrowers can also get a lower interest rate when working with a co-signer because lenders usually base interest rates on the higher credit score, says John J. Vento, a certified public accountant, certified financial planner and author of "Financial Independence (Getting to Point X): A Comprehensive Tax-Smart Wealth Management Guide."
Obtaining a Co-signed Loan
If you're not sure you can get a personal loan on your own, it's a good idea to secure approval from a co-signer ahead of time. That could be "the ace up your sleeve" to make sure you get approval one way or another from a lender, Emancipator says.
The lender and co-signer, though, might want to make sure the loan is a smart financial move for you.
Vento says, "If you are purchasing things that are considered needs, then it's more justifiable. If you're purchasing things you would consider a want, then that's a whole different story."
For example, if you are pursuing a personal loan to consolidate debt, you could show how a lower overall interest rate could help you handle multiple debts at high interest rates.
Emancipator says, "If you could demonstrate you were making payments on time, it would give the bank a sense of comfort that you're making higher interest rate payments and should be able to afford a lower interest payment."
Lenders That Accept Co-signed Loans
There are some personal loan lenders that accept co-signed personal loans. Some of these include:
Risks of the Co-signing Relationship
While it is certainly a magnanimous gesture for a co-signer to agree to partner on a loan, it also carries major risks to their credit rating. In fact, their credit score may take an immediate hit because of the added debt load.
It's in everyone's best interests to spell out the financial arrangement before signing on the bottom line.
As a co-signer, "the risks to your own financial future far outweigh your personal benefits, so be sure to think very carefully before agreeing to co-sign," Vento says. "You should never co-sign unless you have full faith in the trustworthiness of the borrower. You must be willing to stake your money, your reputation and your relationship with the borrower on his or her ability to pay back the loan."
Vento says he has seen several financial and personal disasters caused by co-signing disagreements. In multiple cases, instead of the co-signed loan helping people improve bad credit, the primary borrowers fell into even worse shape and "dragged the co-signer into it." In another example, a woman co-signed a loan for a boat purchase for her husband, but then the couple divorced, and she ended up having to settle the debt herself when her ex-husband didn't pay. She also took a hit on her income tax because of the settlement.
"Co-signing is very rarely a smart choice," Vento says. "The only time you should do it is if you have some control over it."
Defining the Co-signing Relationship
Lenders play a key role in making sure all parties know what they're responsible for once the loan agreement is signed.
"It's important for co-signers to know they're on the hook for the loan just as the primary signer is," Emancipator says. Financial institutions need to detail with both the primary borrower and co-signer the potential risks of entering into this transaction. This step may help avoid situations in which the co-signer is blindsided by missed monthly payments or defaults caused by the primary borrower.
[Read: The Best Bad Credit Loans.]
If you choose to be a co-signer, the lender ought to spell out your obligations in a notice that includes acknowledgment that:
-- You are being asked to guarantee this debt and that you accept the responsibility to do so.
-- You might have to pay the full amount of the debt plus late fees or collection costs if the primary borrower does not.
-- The creditor may be allowed to collect this debt from you, even without first attempting to collect from the borrower (this depends on state law).
In addition to legal requirements, co-signers for debt consolidation personal loans ought to insist that primary borrowers develop a plan that details how they are getting themselves out of debt and how this loan is going to help them get there, Vento says. Co-signers can ask the lender to notify them if the borrower misses any payments or loan terms change.
Vento says it would be ideal if the co-signer were able to act as the primary borrower's financial coach to help the borrower and allow the co-signer to "at least have a little more control over what's going on rather than just signing their name and hoping for the best."
A potential co-signer should know a person very well before agreeing to such an arrangement. In the example of a parent who co-signs a loan to give a child a head start, "there are plenty of cases where that has worked out for the child," Vento says. "The parent, as co-signer, is taking a calculated risk. You're not going to do it for a total stranger."
Before signing, the co-signer also ought to consider:
-- Whether they can afford to pay the loan if needed.
-- If this might affect the ability to get more credit, because this loan will show up as an obligation.
-- Not tying personal property to the co-signed loan, because it could be lost if the primary borrower defaults.
-- Seeing if the lender will limit obligation for the co-signer to a specific part of the loan, such as the principal balance.
Considerations for Primary Borrowers
It might seem that the only risk for this type of loan is for co-signers, but primary borrowers also need to protect their interests. For example, the primary borrower needs to make sure there is a backup plan if the co-signer dies, as some loans have an automatic default clause that requires full repayment upon the co-signer's death.
Another option for borrowers is to see if the co-signer would consider lending them the money directly, which would avoid involvement from lenders and credit reporting agencies.
Finally, given the risks involved for both the borrower and co-signer -- not only financial considerations, but also possibly complicating the relationship between the two -- borrowers need to make sure now is the best time to pursue a co-signed loan.
The bank will put your loan request through a formula to let you know what you can afford on your own. If the bank doesn't think you can afford it, "maybe it's OK to sit back and take a deep breath before you make a large financial move like this," Dworetsky says. "I've had that conversation with many clients." "
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