The possible consequences of cosigning a loan for someone are worth considering before signing your name. Some people hastily cosign a mortgage, auto loan or other type of loan without weighing the pros and cons. By cosigning, you voluntarily increase your debt-to-income ratio, which can make it more difficult for you from acquiring your own financing, or even prevent it.
What is Cosigning?
Lenders may decide that an applicant doesn't meet the qualifications for financing. Perhaps his credit score is too low, or maybe he has a history of late payments. For the application to meet the bank's requirement, lenders may suggest adding a cosigner to the loan agreement. A cosigner is a person (with good credit) who agrees to become a co-borrower. As a cosigner, this individual accepts responsibility for the loan payment, and consents to making the payment if the primary borrower defaults.
Debt-to-Income Ratio
Debt-to-income (DTI) ratio is terminology used to describe the percentage of debt payments in connection with monthly income. A high debt-to-income ratio due to high credit card debt and other loans can lower one's credit score and stop loan approvals. Borrowers can calculate their own DTI ratio by dividing their monthly debt payments by their gross monthly income. For example, a borrower with debt payments that equal $2,000 a month and a monthly income of $6,000 has a DTI ratio of 33 percent.
DTI and Cosigning
The problem with cosigning is that the loan and outstanding balance will appear on your credit report. Once you agree to cosign a loan, you own the debt with the primary borrower. The lender has your Social Security number on file, and the lender will report the debt on both credit reports. When the time comes to apply for your own financing, a lender will see this debt on your credit report, compare this debt with your present income and possibly conclude that your DTI ratio is too high and decline your application.
Considerations
If you are thinking about cosigning a loan to help someone get financing, do the math first to ensure that you maintain a low debt-to-income ratio. Tally this new debt with your present debt payments, and then divide this figure by your present monthly income. Getting a mortgage in your name requires a debt-to-income ratio of no more than 36 percent, with the house payment being no more than 28 percent of your income. If your DTI ratio after cosigning a loan will increase to more than 36 percent, do not cosign the loan.
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