7 Ways to Protect Yourself When Cosigning on a Loan

Table of Contents

1. Understanding The Risks of Cosigning a Loan
2. Assessing The Borrower's Finances
3. Evaluating Your Own Finances
4. Reading The Loan Agreement Carefully
5. Communicating Regularly With The Borrower And Lender
6. Addition Financial Can Offer You Expert Advice

If a friend or family member approached you to cosign on a loan for them, what would be your response? What do you know about being a cosigner? Do you know what to do to protect yourself when cosigning on a loan? These means of protecting yourself cover you before signing, when going through the process, and after signing the loan. We’ll pose some questions at the end of every point so you can think critically about being a cosigner and recognize red flags. 

Understanding The Risks of Cosigning a Loan

When you cosign a loan, you're essentially vouching for the borrower and agreeing to be responsible for the debt if they can't pay. Cosigning makes you fully liable for the debt, which could harm your credit, affect your ability to get future credit, and potentially lead to legal action if the borrower defaults. Fully understanding and acknowledging the risks means that if something negative happens with the loan, you will be more prepared. Consider consulting a financial advisor or attorney to clarify any legal language or potential consequences you don’t fully grasp.

A few questions you can ask yourself before moving forward include: 

• Have you done your research on cosigning?  
• Are you prepared for any possible negative consequences?
• What exactly are you agreeing to when you cosign?

Assessing The Borrower's Finances

If you are considering being a cosigner, you have to be comfortable asking the other person about their financial situation, because this could mean the difference between success and failure on this venture together. You should have a deep understanding of how their finances look by reviewing their credit report, regular budget, and income stability to ensure they can realistically repay the loan. Do they have good credit? Have they had any negative financial situations in the past?

By reviewing these items, you can make an informed decision and know if this person knows how to regularly manage their money, and you can get an idea of what this loan will look like over time for them. If they’ve struggled with money management in the past, it’s a red flag. Trust is important, but transparency and financial accountability are essential when your own credit is at stake, especially if you have worked hard to increase your score. A difficult conversation now can prevent a damaged relationship and credit score later.

A few questions you can ask yourself before moving forward include: 

• Can you realistically assess their ability to repay the loan?
• Have they had any past issues with debt or missed payments?

Evaluating Your Own Finances

It’s important to know if you can afford the payments if the borrower defaults without jeopardizing your own financial stability, and assess your comfort level with taking on the loan yourself if needed. Cosigning means you're legally responsible for repaying the loan if the primary borrower defaults, which could affect your credit score, debt-to-income ratio, and future borrowing power. It’s also wise to have an emergency fund in place in case you’re unexpectedly required to step in.  

Life is unpredictable, so just because your financial situation is good now doesn’t mean that it will always be the case. Being honest about your financial limits now can save you from serious consequences later. Before you sign, consider the long-term implications and how you’ll handle various scenarios. Having a plan for how to deal with missed payments or a loan default gives you more control and peace of mind. Cosigning should never be an open-ended commitment, you need a clear understanding of how and when your role can end.

A few questions you can ask yourself before moving forward include: 

• How could your credit and financial future be impacted?
• Do you have a plan if the borrower defaults?
• Could you realistically cover the loan payments without jeopardizing your own financial goals, such as saving for retirement, buying a home, or paying down existing debt?
• What will you do if the borrower loses their job or decides to stop paying? 
• Can the loan be refinanced later to remove you as a cosigner? 

Reading The Loan Agreement Carefully 

Before you sign anything, take the time to read the entire loan agreement and understand exactly what you’re agreeing to. Ensure you understand the terms, conditions, and your obligations, including the loan amount, interest rate, repayment schedule, and potential penalties. You should also obtain copies of all documents which means keeping copies of the loan agreement, promissory note, and any other relevant paperwork for your records in case you need to refer back to them. This is also a good time to consult with a financial expert to review the documentation if there are any points you don’t understand. 

Some people choose to also set up a more informal written agreement that covers their unique circumstances or promises for communication on the loan and what happens if a payment is missed, etc. 

A few questions you can ask yourself before moving forward include: 

• Are you aware of your legal rights as a cosigner?
• Have you read the fine print on the loan agreement?
• Have you considered creating a separate written agreement?

Negotiating Terms (If Possible)  

Explore if you can limit your liability to the principal loan amount or negotiate specific terms of your obligation. Some lenders allow cosigners to request a “cosigner release” after a certain number of on-time payments—ask about this option upfront and get it in writing if available. You might also request to be notified if the borrower misses a payment, so you’re not blindsided by bad news months later. Setting up a separate written agreement with the borrower about repayment responsibilities and how you’ll handle issues can also provide clarity and protection. These steps won’t eliminate the risk, but they can help you manage it more effectively. 

A few questions you can ask yourself before moving forward include: 

• Do you know what protections (if any) your state laws offer?
• Have you explored ways to limit your liability?
• Can you request to be released as a cosigner after a certain number of payments? 

Monitoring Payments 

You should be diligent in keeping track of the loan’s payment history by accessing the account online or requesting statements from the lender during the original signing process. Another important step is regularly monitoring your credit reports for any missed payments or negative entries related to the cosigned loan, because those would be shown as an impact on your score. 

A few questions you can ask yourself before moving forward include: 

• Can you set up payment alerts that you can easily access? 
• Are you regularly checking your credit?  

Communicating Regularly With The Borrower And Lender 

Just as you are checking in with the payments, you should take the time to stay informed about the borrower's financial situation and any potential repayment challenges. Establishing contact with the lender to understand their procedures and stay informed about the loan status is also advised if, for any reason, you can’t reach the borrower. 

A few questions you can ask the lender before moving forward include: 

• What procedures do you have for contacting cosigners in case of missed payments?
• Do you offer any cosigner release programs? 

Addition Financial Can Offer You Expert Advice  

Before becoming a cosigner, first consider exploring options like helping the borrower improve their credit, providing collateral, or offering a loan from your savings, as this could minimize the negative impact if something goes wrong. If you are considering cosigning a loan through Addition Financial, we’re here to talk about what it means for you and your financial future. If you are considering taking out a loan yourself, check out our options for auto loans, mortgage, and more that are ready to help you reach your goals. Reach out to us today to learn more!