What it means to cosign a contractIf you have excellent credit, someone may have asked you to share your good fortune by cosigning a loan or rental agreement with them. Many know that being a cosigner can help other people qualify for offers they otherwise couldn’t get, but what they may not realize is how extensively cosigning legally binds you to other people’s debt. Before you cosign anything, keep reading to learn what cosigning is, the best conditions under which to do it and how to get out of it.

What is cosigning?

Cosigning is when a person agrees to add their name to a contract as a backer who will cover any debts that the primary applicant does not pay. By cosigning, you can help someone with low income or low credit scores qualify for a loan or lease that they would not be able to secure on their own. You effectively share responsibility for the debt, to the point that it shows up on your credit reports and counts toward your credit utilization ratio, although you do not have any rights to the money or property borrowed. If the primary applicant cannot pay the lender back, the lender can legally pursue you for the remainder of the loan, including late fees, interest and any additional costs related to missed payments.

Guaranteeing a loan is quite similar to cosigning, but differs slightly. While a lender can try to collect money owed from a cosigner shortly after the bill is overdue, guarantors are less liable for the primary applicant’s debt and have more protection when it comes to collections. When you’re a guarantor, a lender must use every tool they have available to collect payment from the primary applicant before they can start trying to collect from you.

When should you cosign?

A cosign on a contract can really help, for example, young people with little credit history qualify for housing, or give a borrower access to lower interest rates and higher maximums than they would otherwise have available. For the cosigner, though, you are risking a lot for almost no material benefit, and effectively putting your financial health in someone else’s hands. Still, if you want to be generous and help someone by cosigning, try to make sure it’s a best-case scenario to minimize your danger. Only consider cosigning for someone you know very well, trust completely and have a permanent relationship with. A parent cosigning for their child is less risky than that parent cosigning for their child’s partner, as if the child and partner break up, then the parent is still liable for the partner’s debt. Additionally, know the details of why the person is asking you to cosign. If they’re financially responsible but just lack credit history, that’s one thing, but if they have bad credit because they have trouble making payments on time, that could negatively affect your credit scores.

It’s also a good idea to factor in the size of the monthly payments, whether you will need to take out a loan yourself in the near future and how cosigning might change your relationship. The size of the payments is important because, if the primary applicant defaults, you’ll be stuck paying the rest of the balance. You need to be sure you can afford those payments on your current budget, or else you may quickly go into debt yourself. If you need to take out your own loan soon, the debt from cosigning a loan will appear on your credit reports and make you appear less able to handle the loan payments. Finally, similar to borrowing money from family, cosigning can change the power dynamic of a relationship and potentially cause tension, especially if the primary applicant can’t make their payments.

Getting removed as a cosigner

With so much liability involved, it makes sense that someone would want to take themselves off of a contract as a cosigner. Unfortunately, lenders don’t typically let cosigners go just because they’ve asked, and in many cases, the only way to get out of a contract as a cosigner is to either pay the remaining debt, or refinance the loan. However, some contracts, particularly private student loans, may contain certain conditions that allow what’s called a “cosigner release.” Usually these conditions involve the primary applicant making on-time payments for a number of months in a row, and may also stipulate that the primary applicant has to agree to the cosigner release, as well. However, many applications for cosigner release get denied by lenders, so it’s an unreliable process.

It’s important to note that the primary applicant declaring bankruptcy or even passing away does not absolve the cosigner from paying any money owed. In fact, some loan agreements contain auto-default clauses, which give the lender the right to accelerate the loan and demand the entire remaining balance in the event of bankruptcy or death for either the primary applicant or the cosigner. Before you cosign a contract, read it carefully and ask the lender about cosigner release procedures.

Cosigning can be a huge help to someone, but that doesn’t make its risks any less real for you. If you’re unsure whether you should cosign an agreement for someone, erring on the side of caution will help you avoid potential disaster. To read more articles like this, follow our personal finance blog.