Applying for a loan, whether it’s a personal loan or a mortgage loan, can be a daunting and intimidating task. Understanding the various terms that might be thrown at you can make the process even more overwhelming if you’re not familiar with loan terminology. One of those terms is a co-maker (or co-signer), which may come up if you have poor credit history, limited credit history, or high debt. Lenders may recommend adding a co-maker to your loan application if they see you as a higher-risk borrower.
What is a Co-Maker on a Loan?
A co-maker is someone who agrees to take on equal responsibility for a loan alongside the primary borrower but doesn’t necessarily benefit directly from the loan. For example, if you have $25,000 in credit card debt and can’t qualify for a debt consolidation loan on your own, you might ask a family member or close friend to act as a co-maker. They would sign the loan agreement, but the loan funds would benefit you, not them.
However, if the person shares the benefits of the loan (such as living in a house bought with a mortgage loan), they are considered a co-borrower, not a co-maker. It’s crucial to understand the distinction between these roles as it impacts the legal obligations involved.
Obligations and Risks for a Co-Maker
Being a co-maker comes with significant legal responsibility. As a co-maker, you are fully liable for making the loan payments if the primary borrower defaults or misses payments. Even though you won’t directly benefit from the loan proceeds, you’re still responsible for repaying it. This loan will be reported on your credit report, factored into your debt-to-income ratio, and considered part of your credit risk for any future loans you apply for.
A co-maker’s legal right and financial responsibility mean that the lender can pursue you for payment if the primary borrower fails to meet their obligations. It’s essential to weigh the potential risks before agreeing to become a co-maker, as any missed or late payments could negatively impact your credit score.
When Do You Need a Co-Maker?
There are several scenarios where a lender may request a co-maker on a loan:
- Low Credit Scores or Poor Credit History: If your credit score falls below 600 (FICO) or 601 (VantageScore), you may be seen as a high-risk borrower. This might be due to past delinquencies, credit card debt, or charged-off accounts. Lenders may require a co-maker with a good credit score to secure the loan. You can read about how to improve your credit score here.
- Limited Credit History: If you haven’t built a robust credit profile yet (common for younger borrowers), a lender may request a co-maker. Having someone with a proven record of handling larger debts, such as personal loans or a mortgage, can reassure lenders of your ability to repay the loan.
- High Debt-to-Income Ratio: Even with a strong credit score, if your debt-to-income ratio is too high (typically above 45%), a lender may require a co-maker. This ratio is a key factor lenders assess to ensure borrowers can manage new loan payments on top of existing debts. A co-maker’s financial stability can help lower your risk in the eyes of the lender.
- Lack of Financial Stability: If you’ve recently changed jobs, become self-employed, or can’t prove income stability through tax returns, adding a co-maker who has a steady income can increase your chances of loan approval.
How a Co-Maker Impacts Your Loan
A co-maker can improve several aspects of your loan:
- Lower Interest Rate and Better Terms: If your co-maker has a strong credit history, this can significantly reduce the interest rate and lead to more favorable loan terms. Lenders consider a co-maker with a good credit score less risky, meaning they’ll likely offer better conditions than if you applied alone.
- Increased Chances of Approval: Even if your own credit worthiness is questionable, having a reliable co-maker can help the lender feel confident about approving your loan.
- Loan Application Process: When applying for a loan with a co-maker, additional paperwork may be required. The co-maker must sign the promissory note and other documents, acknowledging their full legal obligation to the loan. Remember, the co-maker’s debt also becomes part of their financial situation and will impact any future credit applications they make.
Types of Loans and Co-Makers
You can add a co-maker to various types of loans, including personal loans, mortgage loans, and other credit products. Here are some examples:
- Mortgage Loans: In a mortgage loan, a co-maker may be a non-occupant borrower, meaning they help secure the loan without living in the home. Often, parents or grandparents will act as non-occupant borrowers to help their children or grandchildren qualify for a higher loan amount or get better terms. This can be especially useful if the primary borrower has limited credit history or high debts.
- Personal Loans: Co-makers on unsecured personal loans are equally responsible for the loan payments. Adding a co-maker can help reduce interest rates and improve loan terms.
- Credit Cards and Lines of Credit: While less common, some lines of credit or credit cards allow co-makers or co-signers. This can help individuals with low credit scores qualify for revolving credit products.
Risks and Responsibilities for Co-Makers
As a co-maker, your responsibilities are equal to those of the primary borrower:
- Equal Responsibility: You are legally bound to make payments if the primary borrower fails to do so. This includes the loan obligations, interest, and fees. Lenders can come after you for repayment, and if the loan goes into default, it will harm your credit score.
- Potential Risks: If the primary borrower has a history of missed payments or defaults, these risks transfer to you. In the case of an auto loan, for example, being on the property’s title can offer some protection, but in most cases, co-makers don’t hold any ownership of the asset tied to the loan.
- Credit Impact: The loan will be reported on your credit report, affecting your credit worthiness and debt-to-income ratio. Any missed payments will show up as delinquencies, making it harder for you to obtain credit in the future.
Who Can Be a Co-Maker?
A co-maker can be any individual you trust to take on the financial responsibility. Most commonly, a family member (such as a parent or spouse) or a close friend act as a co-maker. It’s important to have a strong, trusting relationship with your co-maker because you are both sharing the debt instrument and any associated risks.
When selecting a co-maker, you want someone with a strong credit history, a low debt-to-income ratio, and a steady income. A co-maker with poor credit history or too much debt could hurt your loan application and may even lead to denial.
How to Know if You Need a Co-Maker
There are a few signs that you might need a co-maker:
- Low Credit Scores: If your score is low or you’ve had trouble managing credit card debt, a co-maker can boost your application. If you want to learn more about managing credit cards, you can read about it here.
- High Debt-to-Income Ratio: If your debt-to-income ratio exceeds 45%, lenders may ask for a co-maker to ensure the loan can be repaid.
- Online Tools and Calculators: Use financial calculators to assess your debt-to-income ratio and whether you’ll need a co-maker to improve your approval odds.
Even if you qualify for a loan on your own, adding a co-maker with a high credit score can lead to lower interest rates and better terms.
Legal and Financial Advice
Before becoming or selecting a co-maker, it’s crucial to seek legal advice and fully understand the legal obligations involved. Financial institutions may require tax returns and other documentation to prove the co-maker’s ability to pay.
Understanding the risks and doing proper due diligence is essential. Adding a co-maker can be a powerful tool, but it’s important to ensure that both parties are fully aware of the responsibilities involved.
Conclusion
A co-maker can play an important role in helping you qualify for loans, especially if you have a limited credit history or high debts. However, it’s vital to understand the legal and financial obligations of both parties. Whether you’re adding a co-maker to improve your chances of approval or becoming a co-maker for someone else, ensure you understand the potential risks and rewards.