Co-signing a personal loan: 6 steps to success

You love your friends and family, and you want them to succeed. That’s why many people don’t even hesitate when they’re asked to co-sign on a personal loan. It’s a beautiful gesture and a real way to give your loved ones a leg up when it comes to paving the way to a better life.  

In order to honor that spirit of mutual benefit, however, it’s also important to protect yourself. Co-signing a loan can have profound impacts on your own credit and financial situation, after all, and you’re smart to consider ways to stay safe. We’ll show you how. 

Check your own credit and finances

If someone isn’t able to qualify for a loan on their own, it’s usually because they don’t have enough credit history, a good enough credit score, or a high enough income. If they ask you to co-sign on a personal loan, it’s important to make sure you’re actually in a position to help them first. 

Start by reviewing your own credit reports and checking your credit score. It’s important to check your monthly budget very closely, too—would you be able to pay back the loan if the main borrower doesn’t? If not, then it might be wise to help the borrower find other options rather than co-signing a personal loan. 

Consider your future borrowing needs

Even if the main borrower makes every payment on time, a co-signed personal loan can still impact your ability to borrow money when you need it. That’s because lenders generally count that co-signed loan as part of your own monthly debt payment, even if you’re only serving as a backup payer on the loan. 

This calculation is known as your debt-to-income ratio, and having a co-signed loan on your credit report means that you may not qualify to borrow as much. If you don’t have any plans to borrow money, then it’s not a problem—but if you plan on buying a home soon, consider whether co-signing is worth it. 

Review the main borrower’s finances and plans

You’ve done the hard work to make sure you can afford the loan if it comes down to it—and it’s wise to do the same for the borrower as well. A good place to start is by asking them why they need the loan. If it’s to make ends meet because they’re living paycheck to paycheck, that could signal problems ahead in repaying the loan. But if they can afford the payment but have a low credit score due to a recent messy divorce or other hardship, you might decide there’s a good chance  they’ll repay the loan. 

The person you’re co-signing for should be comfortable about sharing their finances with you, since they’re basically asking you to do the same for them. Have them show you their monthly budget or help them make one. Create a plan for how they’ll ensure they’re able to repay the loan, to the best of their ability. If their hours are reduced at work, for instance, how will they make up that cash shortfall?

Clarify the fine print in the loan agreement

Have you ever rushed through the legalese when signing a contract? It’s tempting for everyone, but this is one time to make sure you slow down and see what it says for co-signers first. After all, it’s a legal contract. 

In particular, make sure you know the answers to these questions:

• How many days grace period does the borrower have to make a late payment without penalty?

• When, and how, will the lender reach out to you to repay the loan?

• Will the lender allow you to continue payments as usual, or will they demand the loan be repaid all at once, and in full?

• Does the lender offer a co-signer release policy at any time during the loan? Sometimes the co-signer can apply to be released from the loan after the main borrower makes a certain number of on-time payments and as long as the main borrower now qualifies on their own.

A final point here: It’s a good idea to keep any copies of the loan agreement for your own files in case you need to refer to them later. 

Find a way to get payment notifications

Everyone starts with the best of intentions, but sometimes life happens. The main borrower might lose their job, get into an accident, or be hospitalized and unable to make payments or even communicate with you. Whatever the cause, if they don’t make the payment when it’s due, you may not find out until after the fact—and by that time, your own credit may already be damaged. 

That’s why it’s crucial to set up a system so that you know the payment is made on time—and if not, that gives you a chance to make the payment first and avoid any long-term credit damage. Some lenders may offer you online account access for your own records or can send you monthly loan statements to keep you in the loop. If not, ask the main borrower to share their account access and forward you monthly loan statements as proof they made the payment.

Research state-specific co-signer protections

Some states offer safeguards to help co-signers. Now’s a good time to check whether your state has any specific laws in place for this. You can do this by looking up your state’s attorney general or banking agency. 

If you’ve co-signed on a personal loan in Michigan, for example, and the main borrower misses loan payments, the lender is required to send you a letter and give you 30 days to respond before they can take any action against you.