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Sometimes it makes sense to apply for a loan along with another person. Understanding the different options and the role of a potential co-borrower can help you protect your finances and credit.
A co-borrower is another adult whose name appears on your loan documents. The lender will look at the co-borrower's income, debts, and assets along with yours. If your loan is approved, the co-borrower and you are 100% responsible for the debt. If the other person becomes unable or unwilling to make payments, you'll be legally responsible to foot the bill entirely.
Along with sharing responsibility for the debt, the co-borrower usually shares the benefit of the loan. For example, with a car loan, the co-borrower is an owner and has the right to use the vehicle. And when you get a personal loan, the co-borrower gets access to the funds.
As you consider what will work best for your own situation, be sure you understand the difference between a co-borrower and cosigner. A cosigner has financial responsibility but no ownership of the asset.
The main reason people apply together is to make qualifying easier. Being co-borrowers can be advantageous in other ways, too. Here's when it might be a good time to consider adding a co-borrower.
Being co-borrowers on a loan is a serious financial commitment with many potential consequences. It's not appropriate for every situation. Here are a few examples of when you should carefully consider other options before adding a co-borrower.
It's perfectly legal to buy a house before marriage, but be aware of potential pitfalls.
If the relationship doesn't work out, removing one person from a mortgage can be costly and complicated. Laws that apply to divorcing couples might not apply to you.
Also, if you sell the home for more than you paid for it, you won't be able to take full advantage of the capital gains exemption. That's because married couples get a bigger benefit on net profits than single filers.
Unfortunately, if your credit score is less than perfect, getting a co-borrower won't make it better. And depending on your goal, getting a loan with a co-borrower may or may not help you.
If having a co-borrower will make the application easier for the lender to approve and it's appropriate for all co-borrowers to share ownership of the asset, going forward together could make sense.
If, however, you are trying to improve your credit, you've got other options that might help even more. It's entirely possible to get a loan with no credit, especially a credit-builder loan or a secured loan. Another strategy is to postpone your plans until you improve your credit and can get better terms on your own. You might be surprised at how quickly your score can go up, depending on the factors bringing it down.
When you become a co-borrower, the debt will show up on your credit report (and affect your credit score) just like any other loan or credit card account. The account type, account age, and payment history are factored into each co-borrower's score.
In one way, this is great. For example, if the account has a perfect history of on-time payments, you'll both get the benefit to your credit score. Payment history is one of the most important factors.
On the other hand, the debt could create an inconvenience that affects each borrower's debt-to-income ratio (DTI). A higher DTI could make it harder to qualify for a home loan in the eyes of mortgage lenders. This is true even if only one co-borrower has agreed to be responsible for making the payments. A high DTI could also affect either borrower's ability to get a car loan.
If you and your borrower have no intention of applying for other loans, having a joint debt on your credit report won't matter.
All applicants will need to meet lender requirements. The minimum credit score for a personal loan varies, but even if you qualify, the interest rate and fees can be quite a bit higher for applicants with bad credit. That's because virtually all lenders charge people who have poor credit more. And the lender might make an offer based on the lower credit score.
It's possible to increase your credit score in a very short time (sometimes just a few months). This is a good option if you have time to spare. Otherwise, if your co-borrower has poor credit and you don't need both incomes to qualify, the main borrower should apply alone for the better terms.
Any adult can apply for a loan as your co-borrower.
A co-borrower often lives at the same address as the primary borrower. But that isn't a requirement.
Keep in mind that it's best if your co-borrower has good credit. If the co-borrower on your loan application has a low credit score, you might qualify for less favorable terms than you could have gotten on your own. And if a co-borrower's credit is bad enough, you might be rejected altogether.
It's also important to remember that once the loan is approved, its payment history, age, and type will affect the credit scores of all co-borrowers on the loan.
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