A cosigner is someone that signs the loan contract with you to strengthen your application. By signing the contract they are equally responsible for maintaining the loan. That means if you miss a payment, it will be reported to your credit bureau AND theirs, simultaneously damaging both of your credit. Similarly, if you write off a loan, it will show on your credit bureau and your cosigner’s as a written off loan.
If your application is not strong enough on its own then sometimes the banks will give you the option of adding on a cosigner. However, just adding a cosigner doesn’t automatically mean you’ll be approved and in some situations a cosigner will not help strengthen the application. The cosigner has to meet the bank’s requirements, as well.
Cosigning a loan for someone else
If you cosign a loan for someone else that loan will also be factored in to your own personal debt servicing ratio. This is important to consider if you’re ever asked to cosign a loan for someone because even if that person pays the loan perfectly, it could prevent you from obtaining credit that you might need in the future by using up some of your debt servicing ability (by adding a payment to your debts).
Sometimes, people cosign a loan for a friend or family member and then forget about it. When it comes time for them to get a loan of their own they get a nasty surprise on their credit bureau that they did not know about and could have prevented. In some cases, having cosigned a loan for someone else can actually prevent them from obtaining credit for themselves.
You should never cosign a loan for someone if you don’t trust them to be honest with you. If they are going to miss a payment they need to tell you so that you can make the payment and keep both of your credit bureaus intact.
There are pros and cons to being a cosigner and to having a cosigner. It’s important to understand all of the angles before agreeing to be a cosigner and also when asking someone to cosign for you.
How do cosigners help?
Cosigners can strengthen applications in two ways:
- By having a stronger, more reliable credit history
- By adding additional income to increase affordability
If you have had credit challenges in the past or if you are a younger person with no credit history, then a cosigner can help. The banks will look at the cosigner and weigh their creditworthiness alongside your own.
If your cosigner has a strong credit history then the banks look more favorably on your application because that lowers their risk. They assume if you don’t make your payments that your cosigner will.
It’s important to note that with this type of cosigner you must be able to meet the debt-servicing requirements on your own. This type of cosigner does not add additional debt servicing – it only adds strength to the overall credit picture the bank looks at when making its decision.
Usually, this type of cosigner is needed is for younger people who are just starting to build credit. It’s not uncommon for banks to ask for a parent or relative to cosign a loan for a younger person with limited to no credit history. If the young person cannot make a payment, the banks assume the parent or relative will.
Increasing Debt Servicing
This type of cosigner is typically a spouse or common law partner. Banks will actually combine you and your spouse’s gross income and obligations together to calculate affordability.
A lot of spouses share credit products, meaning both are on the mortgage, loans, credit cards, etc. This is why banks will allow you to combine your income and obligations when being considered for a new loan. The banks will assume that between the two of you the payments will be made.
Sometimes adding a spouse on to the application will not help with debt servicing. This is because when your incomes are combined you may still exceed the 40% maximum the banks uphold.
Another thing that can affect your monthly payment on a new car is the term you choose to finance it over and the interest rate you receive on the loan. We will discuss current finance rates and auto loan terms in the next post.