Have you ever been asked by a friend or family member to co-sign on a loan for them? Co-signing, also known as being a guarantor, means you are essentially promising to repay the loan if the borrower cannot. It is a big decision that can have a significant impact on your credit score, both positively and negatively. This article explores how being a loan guarantor affects your credit score and the risks involved.
Role of a loan guarantor
A loan guarantor acts as a safety net for lenders. When someone applies for a loan, the lender assesses their creditworthiness based on their credit history and income. If the borrower has a poor credit score or lacks a steady income, the lender might be hesitant to approve the loan. In such cases, having a guarantor with a good credit score and strong financial standing can increase the borrower's chances of loan approval.
Impact on credit score
The impact of being a loan guarantor on your credit score depends on the borrower's behaviour:
- Positive impact: If the borrower makes all their loan payments on time, it will not necessarily improve your credit score directly. However, it will not hurt it either. In some cases, the loan details might even appear on your credit report, potentially increasing your credit utilisation ratio (the amount of credit you are using compared to your total limit) if managed well. This can be a good thing, but only if the loan is being repaid responsibly.
- Negative impact: The bigger risk lies in the borrower defaulting on the loan. If they miss payments, it will be reflected on both the borrower's and the guarantor's credit reports. This can significantly lower your credit score, making it difficult and expensive to qualify for loans in the future (loans might have higher interest rates or be denied altogether).
What are the risks involved in becoming a loan guarantor?
Before you agree to be a guarantor, consider these risks:
- Financial strain: If the borrower defaults, you are legally obligated to repay the entire loan amount, including interest and penalties. This can put a significant financial strain on you.
- Damaged credit score: As mentioned earlier, missed payments by the borrower will damage your credit score for years to come.
- Strained relationships: Co-signing can lead to tension and arguments with the borrower if they struggle to make payments.
- Limited borrowing power: A high credit utilisation ratio due to the guaranteed loan can affect your ability to secure other loans, like a mortgage or car loan.
Conclusion
Being a loan guarantor is a serious responsibility that should not be taken lightly. While it can help someone you care about secure a loan, the potential consequences can be severe. Before co-signing, carefully assess the borrower's financial situation and creditworthiness. Make sure you have a transparent conversation about their ability to repay and understand the full financial burden you might take on.
