People with poor credit or no credit often require a cosigner to gain approval for a loan. Credit bureaus and lenders view cosigners as joint account owners. When someone cosigns for a loan, the credit bureaus are notified and the payment history of the loan is recorded on his credit report.
History
In 1970, the U.S. government took steps to ensure the equal treatment of credit applicants and passed the Fair Credit Reporting Act. In 1989, The Fair Isaac Corporation introduced a credit rating system in conjunction with Equifax. The FICO system was adopted by the other major credit reporting agencies -- TransUnion and Experian -- in 1991. In the 1990s, the Fair Credit Reporting Act was modified and lenders are now required to report loan balances and payments on a monthly basis to the major credit reporting agencies.
Function
Most lenders use debt-to-income ratios, and credit scores to underwrite loans. People with no prior history as borrowers have no credit scores, and consequently most lenders deny them credit. The addition of a qualified borrower with an established credit history enables many borrowers to gain access to credit. Banks look at the overall credit history of both applicants, so loans with cosigners are normally limited to small amounts and tend to have higher interest rates due to the principal borrower's lack of credit.
Types
Cosigners are usually parents or family members who cosign on credit card applications for college age children. Many banks issue low balance credit cards specifically aimed at students who require cosigners. Automobile loans also frequently have cosigners as parents help their children to build credit and gain access to a vehicle. Banks do not allow cosigners on home loans unless both parties have an ownership stake in the house. Business loans require everyone with at least a 20 percent ownership share to cosign.
Considerations
Acting as a cosigner on a loan can inhibit an individual's ability to apply for further credit even when the loan in question is paid promptly. Credit scores are negatively impacted by new loans because they lower the average length of account history and initially have 100 percent utilization. The payments are factored into a cosigners debt-to-income ratio even when they do not make the payments themselves, and this could cause banks to decline them for other loans due to excessive debt.
Warning
When a borrower makes payment more than 30 days after the due date, the lender reports it to the credit bureaus and it impacts the credit scores of both the signer and cosigner. When a borrower defaults, the cosigner is equally liable for the debt and lenders can pursue the cosigner for payments. Some cosigners are unaware of the delinquency of loans they are involved in until the lender takes them to court.
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