Key learning points
-
Adding a co-borrower or co-signer can increase your chances of approval when applying for a loan and help you secure better terms.
-
Co-signers support the loan but do not have access to the money, while co-borrowers do have access to the borrowed money.
-
Being a co-signer or co-borrower can affect your credit and pose financial risks.
When you apply for a loan, you may have the option to add a co-signer or co-borrower. Both can increase your chances of approval and help you get better terms.
Although there are some similarities, a co-borrower (or co-applicant) shares ownership of the funds or assets secured by the loan. The co-signer, on the other hand, does not. Knowing the difference between the two is imperative when applying for a loan to avoid future misunderstandings.
What are the differences between a co-signer and a co-borrower?
The main difference between a co-borrower and a co-signer is the level of investment in the loan. A co-borrower has more ownership than a co-signer because a co-borrower has access to the loan funds.
| Co-signer | Co-lener |
|---|---|
| Has no legal claim to the funds or assets obtained through the loan. | Equity ownership of the funds or assets obtained through the loan. |
| Liable for repayment from the start, but usually only expected to pay if the primary borrower defaults. | Shares responsibility for reimbursement from the start. |
| The main goal is to help the primary borrower get the loan. | Benefits equally from the loan. |
Co-signatories
A cosigner agrees to take equal responsibility for repaying a loan, although typically not expected to make payments unless the primary borrower misses a payment. The cosigner typically has better credit or higher income than the primary borrower, who might otherwise not get a loan application approved without the help of a cosigner.
Cosigners typically have a close relationship with the primary borrower. A cosigner is usually a parent, immediate family member, partner or spouse.
How it works
A cosigner guarantees the primary borrower. Cosigners promise to take responsibility for repayment if the primary borrower defaults on the loan.
Advantages and disadvantages of a co-signer
Positives
- Can increase primary borrower’s chances of approval.
- It could help the borrower get a lower interest rate.
- On-time payments can improve both credit scores.
- The primary borrower is the sole owner of the money.
Cons
- Must have good credit.
- Both credit scores can suffer if the borrower makes late payments.
- Legally responsible for reimbursement.
- Damaged relationship if the loan is not handled responsibly.
For whom a co-signer is best
Co-signing is usually preferred if only one of the borrowers will benefit from the loan. For example, if a young person without regular credit wants a personal loan, the bank may decide that the loan without a cosigner is too risky. A parent with good credit might agree to co-sign with the understanding that their child will pay it back.
Co-borrowers
A co-borrower, also known as a co-applicant or co-applicant, is a person who shares both ownership and responsibility for repaying a loan with another person. Applying for a loan from a co-borrower reassures the lender that multiple sources of income can be used for repayment.
Applicants with co-borrowers are more likely to receive larger loan amounts because these are considered less risky to lenders.
How it works
In addition to both parties being responsible for making payments on the loan, assets that secure the loan (such as a home or car) may be owned by both co-borrowers. Every co-borrower has equal access to the loan funds. And if the loan was used to secure property – such as a vehicle – both co-borrowers are often listed as owners.
Advantages and disadvantages of a co-borrower
Positives
- It can make it easier to qualify.
- Can make you qualify for a better rate and a larger amount.
- Shared responsibility for refunds.
- Shared ownership of the funds or assets.
Cons
- Hard credit inquiries can cause a temporary dip in both credit scores.
- Risk of paying yourself if the other person cannot help.
- Both credit scores can suffer if the loan is not paid on time.
- Damaged relationships can result in a legal battle over money or assets.
For whom a co-borrower is best
Joint borrowing is usually preferred if both borrowers will benefit from the loan. For example, if two people start a business together, they can take out a small business loan as co-borrowers and work to pay it back together. Both benefit directly from the loan and enter into the transaction knowing that they will both make payments.
How to choose between a co-signer or a co-borrower
The right approach depends on what your goals are with the loan. Consider these factors when choosing between a cosigner and a co-borrower.
Co-signatories
A co-signer does not have to post collateral or accept responsibility for regular payments. If the primary borrower pays on time, the cosigner never has to worry about the loan. They could also benefit from an improved credit score.
On the other hand, if the primary borrower defaults, the cosigner will be on the hook for payments. Additionally, they will not be able to use the loan funds and may have difficulty getting approved for other loans as these will still count towards their overall debt-to-income ratio (DTI).
Co-borrowers
A co-borrower benefits directly from the loan. Lenders may also offer lower rates and higher loan amounts, especially if both borrowers have good credit. And since every borrower has equal responsibility, you may not need to provide additional collateral to secure the loan.
What should I do before signing or co-signing?
Before you lend or co-sign a loan application, have an open conversation with the other person. Determine if the loan is necessary, consider other options, and discuss everyone’s financial situation and future goals.
Because both options carry significant financial risks, you should consider a contract that outlines how responsibility is divided and what happens in the worst financial situations. It is also helpful to research the rights of your state’s co-borrowers and co-signers. There may be protections around property ownership and the impact on credit.
If you’re trying to decide whether to be a co-borrower or a co-signer, consider how much involvement you want to have. For example, if you are interested in accessing the funds or owning part of the asset to be financed, co-lending may be the best option. However, if you just want to help the other person secure the loan and don’t mind being held responsible for payments, then co-signing may be the better choice.
In short
Before you apply for a loan from someone else, ask yourself a few questions:
- Can you afford to make loan payments?
- How stable is your source of income?
- How will co-signing or co-borrowing affect your future goals?
- What are the financial habits of the co-applicant or primary borrower?
Co-borrowing can make sense if you know the risks and want to borrow money together with someone to achieve a common goal. Alternatively, co-signing may be right for you if you want to help someone you trust.
