When you co-sign a loan contract for someone, it means that you’re making yourself legally responsible for the loan should that individual default on their payment obligations.
Essentially, your role is that of a second borrower, where you pledge to pay back the loan if they fail to do so.
Co-signing a loan contract is a common practice employed by those wishing to help a family member or close friend get approved for financing.
In such cases, the person seeking a loan doesn’t qualify for one because they fail to meet the lender’s criteria, which typically includes a minimum credit score and stable income.
A co-signer with a solid financial standing can support and provide their loan application with the extra boost it needs to get approved.
Why do I need a Co-Signer?
Personal circumstances may preclude you from obtaining the financing you need on your own.
In that case, you’ll have to rely on a co-signer to enhance the appeal of your loan application.
Suppose you’re a young student who’s never used a credit product before, having relied exclusively on cash up to this point.
In that case, you’ll likely face obstacles when trying to acquire a line of credit, mortgage, auto loan, or another type of financing.
The reason is that you lack credible experience handling debt, which means lenders can’t measure the risk of extending a loan to you.
With no credit history and a non-existent credit score, they can’t assess your ability to make timely payments.
Another scenario where you might need a co-signer is when your finances have deteriorated to the point where obtaining a loan on your own is impossible.
Past financial mistakes can erode your credit score over time, and it can take considerable time and effort to repair it.
Suppose you’re unemployed or earn an erratic income because you work strictly on contract.
In that case, you’ll face hurdles acquiring a loan since lenders want assurance that you have enough money to make regular payments.
No matter which scenario describes you, a co-signer can vastly increase your chances of acquiring financing at a favourable interest rate.
You’ll also gain the opportunity to establish or improve your credit score along the way.
The co-signer is subject to a hard credit check and employment verification, just like the primary borrower.
Considerations before becoming a Co-Signer
Before agreeing to be a co-signer for someone, you should carefully consider both the personal and financial implications of doing so.
- Your finances could suffer
Are you prepared to assume the financial commitment of regular payments if the primary borrower defaults? Taking on additional debt may strain your budget and cause financial hardship for your household. If you miss payments, debt collectors may pursue you aggressively, and your credit score will decline. Ensure that you have the financial cushion to effectively manage the loan should you have to step up and take responsibility for it.
- Co-signing a loan may affect your ability to borrow
When you co-sign a loan, you’re essentially adding to your current debt load, which could hinder your ability to secure financing in the future. Lenders may be less willing to extend credit to you if they spot a co-signed loan on your credit report.
- You risk damaging your relationship with the borrower
A co-signed loan contract can cause tension in your relationship with the primary borrower. If you’re not fond of the financial behaviour of the primary borrower, this may lead to undue stress and tension.
Guarantor vs Co-Signer
The terms co-signer and guarantor are often used interchangeably, but they refer to entirely different concepts.
While both refer to a third party that leverages their financial standing to help a borrower acquire financing, there are crucial differences regarding their rights and responsibilities.
A co-signer must sign the loan application form and other applicable documents.
Their name may also appear on the property’s title for which the loan is financed, which means they retain some ownership rights.
Co-signers assume liability for regular payments should the primary borrower default.
Typically, co-signers are used when the primary applicant has a weak credit profile.
A guarantor has similar responsibilities to that of a co-signer in that they’re accountable for regular loan payments should the primary borrower default.
However, lenders will typically require the guarantor to assume responsibility for payments after they’ve exhausted all reasonable means of extracting the money from the original borrower.
Conversely, the lender may require a co-signer to accept responsibility for the debt much earlier, even if they’re currently pursuing the original borrower for payments.
A guarantor’s name is never listed on the title of the property underlying the loan, so they don’t benefit from any ownership claims.
In general, guarantors are used when the primary borrower has satisfied most of the lender’s criteria but still needs a little extra help in getting their application approved.
Did You Know?
The co-signer for a mortgage loan may be liable for part of the capital gains tax resulting from the sale of the property if their name appears on the title.
Removing a Co-Signer from a Mortgage in Canada
Let’s say you had a family member co-sign your mortgage.
But two years later, circumstances have changed, and you’ve decided it’s time to release them from this commitment.
Suppose you wish to remain with your current lender.
In that case, you’ll have to requalify for the mortgage on your own merit, which means you’ll have to have good credit and a reliable income.
You may also be subject to the stress test and possibly need to contribute an additional down payment.
Keep in mind that your lender may decline to remove the co-signer from the contract if they feel you’re incapable of servicing the debt on your own.
Your lender will draft new mortgage documents that list you as the sole borrower if you successfully requalify.
However, in some cases, the process may entail refinancing your mortgage, which is more onerous and time-consuming.
Since refinancing involves breaking your mortgage contract, you may have to pay a prepayment penalty.
Be sure to speak with your mortgage provider about your options and the procedure for removing a co-signer.
What Rights Does a Co Signer have on a House?
A person who co-signs a mortgage contract has their name listed on the home’s title.
As a result, they inherit property rights alongside the primary borrower.
The co-signer may choose how to divide the property ownership rights to minimize any future tax consequences.
For example, they could allocate up to 99% ownership to the primary borrower and only 1% to themselves.
Since a co-signer retains part ownership rights to the home, the primary borrower must obtain their consent to sell it.
Co-signing a mortgage reduces the amount of Land Transfer Tax Rebate you’re eligible for as a first-time homebuyer in Ontario.
Frequently Asked Questions
- Is co-signing a bad idea?
In general, you should avoid co-signing a loan, as it can negatively affect your finances.
Should the primary borrower default, you’re automatically accountable for future payments, which could consume a sizable chunk of your budget. Falling behind on payments can severely damage your credit score and result in the lender seizing your assets.
Co-signing a loan confers little or no benefits and exposes you to a wide range of risks. As a result, you should only act as a co-signer out of a genuine need to help a trustworthy family member or close friend.
- Is a co-signer an owner?
In most cases, an individual receives no ownership rights when they assume the role of a co-signer. In the case of a car loan, the co-signer would have no legal right to use the car without explicit permission from the primary borrower. Their only responsibility is to guarantee the loan payments in the event the primary borrower defaults.
The one exception is a co-signer on a mortgage. In this case, the co-signer’s name appears on the property’s title, which means they retain some level of ownership status.