Are you thinking of cosigning on a mortgage for a friend or family member? You have wondered – does cosigning hurt your credit score? The short answer is a resounding yes. While portrayed as helping out family, cosigning a mortgage puts your credit score and financial future at great risk if payments are missed.
Before you cosign on a mortgage for anyone, it’s critical to understand exactly how this decision can severely damage your credit standing and borrowing power for over 15 years.
This guide will outline the substantial impacts on your credit score and borrowing power when cosigning in Canada. It explores massive financial risks, ways cosigning obligations hurts your credit rating, options to remove yourself after, and, most importantly, safer alternatives to avoid damaging your financial future.
Overview of Cosigners in Canada
A cosigner is someone who legally agrees to repay a loan or debt obligation if the primary borrower fails to make payments as originally agreed upon. Essentially, the cosigner promises to take over any missed payments or pay the outstanding loan balance if the primary borrower defaults.
The cosigner is considered a co-borrower alongside the primary borrower on any document. Their name, personal details, and signature are included on all paperwork and the loan contract.
As a cosigner, you have a lawful obligation to:
- If the primary borrower stops paying, make the payments yourself. This means being prepared to take over the monthly payments, even if you don’t use the purchased asset.
- Pay off the full outstanding loan balance if the primary borrower defaults. If the primary borrower stops making payments, you may need to cover the remaining principal plus any accumulated interest and penalties.
- Honour the entire term of the loan – The cosigner is bound to the debt for the full duration of the loan, typically 3-7 years for personal loans and 25-30 years for mortgages.
Read a full guide about Cosigning a Mortgage in Canada
Typical Reasons Why Canadians Become a Cosigner
While certainly risky, here are some of the more common circumstances where someone may consider being a cosigner:
- To Help a Family Member or Close Friend
Many decide to cosign for a younger relative, such as a child or sibling, who struggles to get approved for a mortgage and help them build their credit.
- To Build or Establish a Credit History
Some with limited credit see cosigning as an opportunity to demonstrate a track record of positive on-time payments. However, the risks often far outweigh any potential credit-building benefits.
- To Share in an Asset’s Appreciation
With a mortgage, the cosigner becomes a partial owner and may profit from rising home values over time. However, there is still substantial financial risk involved.
While the motivations may be noble, it’s vital to consider cosigning objectively before making any binding commitment. The following sections will outline just how substantial the risks and responsibilities can be.
How does Cosigning Hurt your Credit Score?
When you cosign a loan in Canada, it’s not just reflected on the primary borrower’s credit report; it also appears on yours. You’ll be equally responsible for it from the perspective of any lenders reviewing your creditworthiness.
In Canada, the approximate weighting of factors that contribute to your score is Payment history (35%), Credit utilization (30%), Credit history length (15%), Credit mix (10%), and New credit inquiries (10%).
Read more: Credit Score in Canada
Potential Negative Impact
Payment History Impact
- One missed payment can lower a top credit score by 100 points.
- 30 days late is reported to the credit bureau and stays on your file for up to 6 years.
- Scores fall 90 days past due and continue declining until the debt is repaid.
- Collection accounts from default are on your credit for 6-7 years.
Credit Utilization Effect
- Balances owed hurt your score if the credit utilization ratio exceeds 30%.
- Lenders see you as an overextended borrower when the ratio is too high.
- The optimal ratio is below 10% for the biggest score improvement.
- Even occasional high utilization causes lasting score damage.
Credit History Influence
- The average age of credit history shortens when new accounts open.
- Extensive history with aged accounts raises your score over time.
- Closing unused cards lowers your credit history length, hurting your score.
- Long-standing accounts show lenders you can use credit responsibly.
Credit Inquiries Impact
- Hard inquiry when applying to be a cosigner dings your score.
- Too many inquiries in a short timeframe are seen as high risk by lenders.
- Inquiries drag down your score temporarily for 12 months.
- Keep new applications minimal to avoid excess credit checks.
Can Cosigning Help Build Your Credit?
Conventional wisdom says that once all payments are made on time, a cosigned loan or mortgage can help build your credit history. The positive payment record is reflected in your credit file.
In reality, the damaging effects often nullify any potential positive impacts:
- Missed payments hurt far more than perfect payments help – A single 30-day late payment can cause a very good or excellent credit score to drop 63 to 83 points. Yet on-time payments only help increase high scores by a few points monthly. [Source]
- Utilization ratio increase lowers score – The balance owed raises your credit utilization level, which accounts for 30% of your total score. Too high a ratio drags down your score.
- Credit history shortened – The new loan lowers the average age of your credit history, which makes up 15% of your score calculation. You want a longer established history.
- Inquiries about your score initially – The hard credit check required to become a cosigner results in an inquiry, temporarily lowering your score. Too many inquiries are seen as risky.
Cosigning may strengthen your credit only if you have no credit history. It demonstrates that you can handle an installment loan responsibly. Yet other ways to build credit, like secured cards, are far less risky.
How Cosigning Reduces Future Borrowing Power?
Less ability to be approved
Lenders reviewing a future application from you may deny it outright or reduce approval amounts, given your existing duty to the cosigned loan. They see you as a riskier borrower.
Those offering approval often require a sizable down payment and only lend conservatively relative to your total earnings.
Higher Interest Rates and Unfavourable Terms
Due to elevated risk factors like your lowered credit score and higher credit utilization ratio, lenders will charge substantially higher interest rates on anything they approve.
You’ll also face tighter lending conditions, such as larger down payments, shorter payment terms, and a lack of flexible options.
Lower Maximum Mortgage Amounts
The cosigned liability directly reduces the total mortgage amount you’d qualify for.
Lenders must factor your legally binding financial obligation into the debt-to-income calculations to determine your maximum eligible loan amount.
This restricts your ability to make large asset purchases requiring financing like home buying.
Difficulty Cosigning for Others Down the Road
Ironically, having a loan cosigning obligation yourself hinders your chances of being approved as a cosigner for someone else in the future.
Lenders look at your existing duty and see your available income being redirected. This pushes other cosigning requests into guaranteed denial territory.
What if the Primary Borrower Defaults?
As a cosigner, you must be financially prepared and have the means to completely take over all loan payments or pay off the large balances that can be outstanding. Otherwise, your credit score and borrowing power may be severely hampered for up to 15 years under Canada’s credit reporting rules.
Should the worst happen and the primary borrower defaults, you realistically have only two options as the cosigner:
Pay Off the Loan Yourself
This path preserves your credit standing by keeping the loan current and avoiding default. However, it also burdens you with repaying a loan, likely for an asset you can’t fully use or repossess, like a mortgaged home or financed vehicle.
You’re faced with covering potentially sizeable amounts in missed payments, interest, fees, and principal balance. For larger loans, this financial obligation could go on for years.
Allow the Loan to Default
The loan will default once payments cease if you cannot afford to pay. This immediately devastates your credit score and, under current rules, remains on your credit bureau profile for up to 15 years.
Lenders, collection agencies, and even the judicial system can then take action to recover what’s owed from you directly, including:
- Selling loan balance to an aggressive collections agency
- Lawsuits and legal action against you
- Seizing assets like bank accounts through court judgments
- Garnishing your wages or employment income
This path severely constrains your finances and borrowing ability for over a decade after default. Any credit you may qualify for will have completely unfavourable terms like high-interest subprime lending.
How to Remove yourself as a cosigner in Canada?
Having second thoughts after cosigning? Unfortunately, removing yourself from the loan and associated liability is not always straightforward.
Refinancing the Mortgage in the Primary Borrower’s Name
The primary borrower must fully qualify for a new loan based only on their income, assets, credit score, and debt levels. This proves to lenders that they can handle the loan themselves.
You’ll then need to sign a contract releasing you from the original debt obligation. Record the loan satisfaction document at the appropriate government agency.
This process works best if the primary borrower’s finances have improved significantly since initially applying with your cosigning help. It takes time and diligent credit rebuilding.
Paying Off the Entire Outstanding Balance
Settlement of the remaining principal, accumulated interest, and any fees remove the debt from the records of lenders and credit bureaus.
However, if the borrower cannot afford to pay off the balance themselves, you may have to cover an extremely large lump sum payment, which requires major financial sacrifices.
Reviewing the Contract for Any Cosigner Release Clauses
A small number of lenders may allow removing a cosigner if the primary borrower meets predetermined criteria like:
- Paying a certain percentage of the loan principal
- Making a set number of consecutive on-time payments
- Securing their standalone refinancing
Yet these provisions are rare in standard mortgages, personal loans, and other common credit agreements. When initially signing, you would need a cosigner release contract.
Alternatives to Being a Cosigner in Canada
If asked by someone close to you, consider safer ways to support their financing needs without putting your credit on the line as a cosigner:
- Gift part of the down payment amount to reduce their borrowed principal and interest costs.
- Lend your own money privately with clear repayment terms. Be prepared to potentially not get it back.
- Let them demonstrate improving credit for 6-12 months before co-applying.
- Add them temporarily as authorized users on your credit card to help build their score. Monitor their spending closely.
- Refer them to free accredited credit counselling agencies to create a repayment and credit-building plan.
- Help them find alternative financing like secured cards or lender mortgage programs for bad credit borrowers.
- Suggest additional upfront costs be built into the loan to offset risks like mortgage insurance premiums.
- If possible, add yourself as a guarantor, which puts your assets/income on the hook only if they default. However, it’s still very risky.
Speak to a Mortgage Experts!
Cosigning on a mortgage or a loan for any friend or family member is a decision that should not be taken lightly. Before agreeing to it, consult qualified financial professionals who can objectively assess if it makes sense in your unique situation.
At Best Mortgage Online, our highly experienced mortgage brokers can discuss the implications of cosigning on your credit standing and financial life in Canada. We’ll explore ways to support your loved ones without jeopardizing your stability.
Contact us today for sound, unbiased guidance on cosigning. We’re always here to help protect your credit health and best interests!
FAQs
Does cosigning affect your credit score in Canada?
Yes, any missed or late payments by the primary borrower will damage the cosigner's credit just as much. Even on-time payments may not improve your score enough to offset risk.
Can a cosigned loan improve your credit if paid on time?
Potentially, but the risks often outweigh the benefits. Late payments hurt far more than on-time payments help improve scores.
How long does a cosigned loan impact your credit in Canada?
The cosigned loan will affect your credit as long as it remains open. Even after it is paid off, it contributes to your credit history for up to 15 years.
What happens if the primary borrower stops paying the cosigned loan?
As a cosigner, you become legally responsible for repaying the loan in full yourself, or your credit will be severely damaged.
Can a cosigner remove their name from the loan later?
Yes, by only refinancing in the primary borrower's name or paying off the balance. But both options are often complicated.
Should I cosign for my child or relative in Canada?
You take substantial risk as their missed payments can devastate your credit. Only cosign if you're able and willing to make payments yourself.
Does cosigning a loan affect your debt ratio?
Yes, lenders count the full balance of the cosigned loan when calculating your debt-to-income ratio. This can reduce approval chances for your own loans.
Can cosigning prevent me from getting a mortgage?
It could, as the obligation reduces your borrowing power for a mortgage down payment. Lenders may see you as too high risk.
Is cosigning better or worse for credit than being a guarantor?
Guarantors have slightly less liability but still considerable risk. Overall, cosigning and being a guarantor both damage your credit if defaulted on.