If you are looking to consolidate debt with a new personal loan and have a low credit score, your lender may request you get a debt consolidation cosigner before approving your application. The question is, should you ask a friend or family member, with better credit than you, to take the financial risk? If you do, what will your lender require of your debt cosigner?
Why you may need a cosigner for a debt consolidation loan
A debt consolidation loan rolls multiple high-interest debts into one new loan. Your potential consolidation lender is deciding the risk they are willing to take in allowing you to pay down debt you owe someone else, with new money they lend to you.
Lenders will look to three factors to determine your creditworthiness – your credit score, your income or ability to afford payments, and your current debt load.
Insufficient credit score
Your consolidation lender wants to loan you money, but they also expect to be paid back. They want to loan to someone with a proven track record of borrowing and repaying loans. If you have bad credit your lender may decide that there is too high a risk you will default on the loan in the future.
Lack of income
You may not have sufficient income to support the required monthly debt payments, especially if you don’t qualify for a loan at a lower rate. Lenders are also reluctant to loan money if you are self-employed, earn commissions or work under contract, all of which can mean your income is not stable enough to support the loan payments.
Too much debt
Even though you are applying to consolidate debt to help with your debt management, if the lender decides the total amount of debt you carry is too high, they may deny your application for more money. After all, you are not reducing your debts through a consolidation loan; you are just shifting money from one lender to another.
To reduce their lending risk, and ensure payment, your consolidation lender may ask you to get a cosigner. The lender wants someone with better credit to cosign or guarantee payment in the event you fail to pay back the loan.
How a cosigner can improve your loan application
A cosigner improves the quality of your application by providing the credit history you lack.
By providing an additional income source of income, a cosigner shows they can repay the loan if necessary. Your lender will look at your cosigner’s debt-to-income ratio to see that they have the capacity to make payments if you don’t.
As a guarantor of your loan, your cosigner will also need to have a good credit score and must have a proven track record of repaying debts because they feel you don’t.
Your co-borrower must also have some available credit capacity – meaning they can’t carry a lot of excess debt themselves.
There are many benefits to getting someone to cosign a loan. Getting a cosigner can help you:
- Lower the interest rate you will be charged on your loan,
- Reduce the amount of down payment or security deposit you will need to make,
- Provide potential assets to secure the loan, and of course
- Increase the chances of your application being approved.
Responsibilities of a loan cosigner
Your cosigner is responsible to repay the debt if you don’t. If you default on payments, your lender will contact your cosigner and demand payment. Depending on the terms of the loan agreement, they may ask your cosigner to continue to make monthly payments or may demand payments of the loan in full all at once. They will also be responsible for the same late fees and interest penalties you would be under the original terms of the loan.
Your cosigner may receive calls from the lender or a collection agency.
Because your cosigner steps into your shoes, cosigning a loan can affect their credit score. As a co-borrower, they have applied for the loan with you, promising repayment. Your consolidation lender may report the loan on their credit report as well. Because they now have a higher credit utilization, this will affect their ability to borrow in the future until your consolidation loan is paid off.
You must have the consent of the lender to release a cosigner from any obligation for a cosigned debt. Often this requires the primary borrower to refinance after they have improved their credit score sufficiently to qualify for a new loan on their own.
Should you get a debt consolidation loan without a cosigner?
The most common types of cosigned loans we see are private student loans, car loans, and low credit consolidation loans. All these loans can lead to substantial repayment risk for both the borrower and cosigner.
Asking a friend or family member to help you get a loan may sound like an easy solution to your debt problems, but it can harm your relationship if things go wrong. Your cosigner is still liable if you file bankruptcy.
I have met with people who have had to file a bankruptcy or proposal because they cosigned a loan. It is not unusual for us to file insolvency for both the borrower and co-borrower.
No matter what, you want to avoid making common debt consolidation mistakes.
Going it alone can also mean taking on a high-interest consolidation loan. Non-traditional lenders are usually more than willing to provide you with an installment loan or $15,000 line of credit at rates of 39% to 49%. A high-interest consolidation loan may seem like a good idea when they tell you the monthly payment is less than you are making today, but in the long run, it’s generally a bad way to consolidate problem debt.
Consider a consumer proposal as an alternative
Rather than getting a cosigner, you could reduce the amount you are borrowing, wait to improve your credit, or if you can offer some collateral of your own. However, I know this isn’t always feasible for someone with a lot of debt.
If your consolidation lender thinks you can’t afford to pay back your debts on your own, they may be right. If that’s the case, you may qualify for a consumer proposal.
With a consumer proposal, you make an offer to your current creditors to repay what you can afford. You still get to make one lower monthly payment, but you are not risking anyone else’s finances. Sometimes a debt settlement approach is better than getting a new debt consolidation loan.
There are many ways of consolidating your debt without causing more financial hardship. Talking with a Licensed Insolvency Trustee is one way to explore your consolidation options.