Co-signing a loan means acting as guarantor for the main borrower and betting your credit on your ability to repay.
When deciding to co-sign, your primary focus should be on the probability of default. After all, if the person you’re co-signing isn’t paying the bills, you’ll have to cover them – and your credit could be damaged in the process.
But there’s another reason you might wish you hadn’t said yes to the co-signing, even if the primary borrower repays the loan on time and in full. You could end up affecting your own ability to borrow in the future, even if everything goes well.
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Don’t forget this possible consequence of co-signing
When you co-sign a loan, the debt appears on your credit report since you are one of the people who are legally responsible for paying it.
The problem is, when you need to take out a loan, like a mortgage, car loan, or personal loan, lenders will take your debt-to-income ratio (DTI) into account when deciding whether or not to allow you to borrow. And they won’t distinguish between your personal debts and those you co-signed for.
Your DTI is the amount of your total monthly debt payments compared to the amount of your income. If you have co-signed for a loan, its monthly payment is included in your DTI. And that could potentially cause you to go over the limit for borrowing or getting the best rate.
Say, for example, you are trying to get a mortgage from a lender who wants your total debt payments, including your mortgage, to be less than 43% of your monthly income. Suppose you have a monthly income of $ 4,000, a car loan of $ 300 per month, and no other debt, and you want to borrow $ 1,200 per month to buy a house. In this case, your DTI would be less than 43%. ($ 1,500 in debt divided by $ 4,000 in monthly income equals 37.5%.)
But if you co-signed for a friend’s personal loan that has their own monthly payment of $ 300, that would push you into a total monthly debt of $ 1,800. Since your debt repayments would now consume around 45% of your monthly income, you probably won’t get your home loan. ($ 1,800 in debt divided by $ 4,000 in monthly income equals 45%.)
Unfortunately, your monthly co-signed loan payment will continue to affect your ability to borrow until the loan is fully paid off – even if the primary borrower regularly makes payments on time and there is no reason. to believe that you will be stuck covering the cost of borrowing. The higher the monthly loan payment you are co-signing for and the longer the repayment period, the more likely it is that your own borrowing capacity will be compromised.
It is important to consider this consequence of co-signing before agreeing to do so, even if you have no reason to believe that the person you are helping get a loan will not pay it back on time. If you are planning to go into debt on your own in the near future, you may need to say no so that you don’t close your own borrowing options in your attempt to help a friend.