Have you ever been rejected for a loan? Or maybe you know someone who has. It’s not a fun feeling, but you’re not alone. Banks rejected 20% of mortgage applications in 2018. While we don’t have exact rejection data for other loans and more recent mortgages, Credit Canada sees hundreds of clients with similar experiences.
So, you might consider getting a co-signed loan. More earning power, more backup, and more likelihood of approval and low interest, right? Yes, but co-signing doesn’t always make financial sense. In fact, our certified credit counsellors advise you to tread carefully with co-signed loans.
Before you ask a family member to co-sign a loan (or before you co-sign for someone else), keep reading. We’ll cover the differences between co-signer and guarantor, responsibilities and risks, credit implications, and when you should or shouldn’t co-sign a loan.
Co-Signer and Guarantor: Responsibilities and Impact on Credit
You can apply for a loan with either a co-signer or guarantor. Both guarantee your credibility, but in different ways. Today, we’ll use mortgages as an example; however, you can still apply most of the info below to personal and car loans.
A co-signer is equally responsible for a home loan as the original applicant, but also has their name on the property title once approved. Usually, applicants with insufficient income will need a co-signer to get approved for the loan.
- Reason: Applicants who seek a co-signer likely have insufficient income for loan approval. A co-signer helps them pass any stress tests and gain approval.
- Credit Impact: All loan payments and credit inquiries are reported to the credit bureau, improving or worsening credit accordingly for co-signers. Additionally, the loan will increase a co-signer’s debt-to-income ratio, reducing the chance of approval for future loans.
- Responsibilities: Co-signers are 100% responsible for the loan at all times.
- Non-payment from applicant: A lender will immediately go to the co-signer for payment.
- Death of applicant: A co-signer inherits an applicant’s debt.
- Divorce from applicant: A co-signer is jointly responsible for their divorced partner’s debt.
- Success: Co-signers are likely to secure a loan because they bring more income to the table.
- Documents required: Co-signers usually need solid credit history and sufficient proof of income. Co-signers are also part of a mortgage title, meaning their signatures must be on all legal documents related to the loan, including the title.
A guarantor is equally responsible for a loan as an applicant, but they do not have their name on the title. Applicants who seek guarantors usually have enough income for loan approval. However, a guarantor helps secure more favorable loan terms and lower interest rates.
- Reason: Applicants have sufficient income for the loan but might only be approved at a high-interest rate because of poor credit history.
- Credit impact: All loan payments and credit inquiries are reported to the credit bureau, improving or worsening credit accordingly for guarantors. If the applicant misses a payment, the co-signer’s credit score might dip. However, guaranteeing a loan doesn’t affect the guarantor’s debt-to-income ratio, making it possible to still be approved for future loans.
- Responsibilities: Guarantors are only liable if the lender can’t obtain payment from the original applicant.
- Non-payment: The lender will only go to the guarantor if they’ve legally tried every other avenue to obtain payment from the applicant.
- Death: A guarantor will inherit the applicant’s debt.
- Divorce: A guarantor is not responsible for their ex-spouse’s death. Only a co-signer with property rights would be responsible.
- Success: Guarantors might help secure a better interest rate, but co-signers are more likely to help an applicant secure approval if their income isn’t adequate.
- Documents required: Credit score and history; Proof of income.
Bottom line? Both co-signers and guarantors are technically on the hook for the loan if the original applicant defaults, even in death. However, co-signers take on more liability.
So, is it ever a good idea to get a co-signed loan?
When it Makes Sense to Get a Co-signed Loan
Co-signing a loan is an immense responsibility. Depending on your status (co-signer or applicant), consider a co-signed loan only if you meet some of the criteria below:
As an Applicant:
You have poor or limited credit history: The average credit score in Canada sits at around 650, but we all know how finicky statistics are. Many Canadians have lower scores, and 650 might not even be enough for an A-bank to consider your application anyway. Then, there’s the issue of limited credit, which is the case if you’re a student or newcomer. If you have the income but inadequate credit history, a co-signer is a great way to secure a loan with decent terms and competitive interest.
Your co-signer candidate is a responsible, trusted family member, friend, or spouse: Remember, a co-signer might not have the same rights as a co-borrower, but they still have their name on your loan title. Additionally, they could sue you if you default. Make sure your co-signer is a trusted family member that will truly have your back if you default.
You have a higher debt-to-income ratio: Perhaps you have a high debt-to-income ratio, but you’re confident you can still make your payments. In this case, a co-signer can help you qualify.
You’re self-employed: Banks are pickier with business owners when it comes to personal loans, mortgages, and more. While you might bring in enough income to qualify, you pose more risk, and lenders might demand a higher interest rate. Additionally, they might require more income history from you than other applicants.
As a Co-Signer:
The applicant is someone close to you and responsible: Maybe the applicant is your daughter or spouse — love plays a role, but make sure you look out for your own interests as well. Observe the applicants’ history and make a judgement call before co-signing.
You want to improve your credit score: This one is tricky. Most lenders require you to have impressive credit to co-sign a loan. However, some private lenders might allow a co-signer with poor credit if they have the income to back up an applicant. The benefit here is that regular payments will improve both the applicant and co-signer's credit score.
When It (Usually) Doesn’t Make Sense to Get a Co-signed Loan
As an Applicant:
You have insufficient income: Experts at CIBC recommend you reconsider the loan altogether if you don’t have the income to qualify. Think about whether you can actually make your loan payments once approved. Of course, this might not apply to a student loan, where you wouldn’t be liable for payment until after graduation.
You have time to think about it: What’s the rush in getting the loan now? Is there a reason stopping you from building more credit history or saving for a bigger down payment? If not, consider waiting until you can qualify for the loan yourself.
As a Co-Signer:
You have plans to take out more loans in the near future: Planning for a car loan or new mortgage down the line? Your newly high debt-to-income ratio might disqualify you after co-signing a loan for someone else.
You don’t trust the applicant: Is this a sibling or family member that’s notorious for debt? Then why on earth would you tie your finances to them? You’re allowed to say no, and that’s that.
Find Debt Relief with Credit Canada
Co-signed loans boost chances for approval and lower interest rates. However, nothing comes free! The responsibilities attached warrant serious consideration before you sign on the dotted line.
Is your debt stopping you from getting a mortgage? A co-signed loan isn’t your only option. Try out free credit counselling from our certified experts!