A business loan cosigner is an individual who signs on to guarantee a loan’s repayment in order to increase the odds of a borrower’s approval. The cosigner is 100% liable for the loan, just like the primary borrower. A cosigner is most helpful for borrowers with bad credit and startups looking for business financing.
In this article we discuss when a business loan cosigner is used and how it can increase your chances of get financing for your business. Before we get started, check your credit score for free so you know how much a cosigner is likely to benefit you.
How Using a Business Loan Cosigner Works
A lender typically requires you to find a cosigner if they aren’t comfortable with your ability to repay the loan due to your credit score, a recent bankruptcy, declining revenue, or not having enough business history. In other words, after they’ve completed their due diligence and decided they need more security to assure them that the loan will be paid in full.
Another name for a business loan cosigner is a guarantor, because they’re guaranteeing the loan will be paid if you default. This means a cosigner can be collected from in the event of a default, just like the borrower. Although many states must first attempt to collect from the borrower before they try to collect from the cosigner, they don’t have to exercise all collection options before moving on to the cosigner.
A loan cosigner may also help business owners get access to higher loan amounts than they can qualify for by themselves, but a cosigner won’t give them access to lower rates, according to Susan Lamping, Vice President at nonprofit CDC Small Business Finance. Your rates are based on the lowest credit score on the application, so a cosigner typically won’t bring down your costs. But if you currently qualify for a loan and are looking to get approved for a higher amount, a cosigner might be able to help.
How the Cosigning Process Works
Some borrowers who know they’re unlikely to qualify on their own for a business loan will preemptively find a cosigner to improve their chances of lender approval. But most of the time the loan provider will ask you to find a cosigner after running into a problem with your application (this could be in the prequalification stage or after underwriting). The business co-signing process typically happens in five stages:
1. Apply for a Loan
You seek financing for your business and submit an application to a lender.
2. Informed a Cosigner is Needed
After reviewing your full or partial application, the lender informs you that you’re unlikely to be approved for the loan (or for the full amount requested) without a cosigner.
3. Find a Good Cosigner
If you want to move forward with the application, you’ll need to find a good cosigner. This person will be someone who either has a better credit profile than you and/or who can pledge sufficient assets as collateral.
4. Lender Re-Assesses the Loan Request
The loan provider will now typically look at both you and your cosigner as a joint application, credit-wise, and give a new decision.
5. Agree to Loan Terms
If adding the cosigner to the application was sufficient for approval, you and your cosigner must both jointly agree to the terms of the loan. Both of you must sign all loan documents.
The largest difference between getting a cosigner for a personal loan compared to a business loan, is that the business loan provider will typically want to see actual assets the cosigner can pledge as collateral. This may make it more difficult for you to find someone willing to cosign your small business loan. Not only might it make your pool of potential co-signers smaller, but some might be resistant to the idea of pledging collateral.
Once you have a cosigner, they’re 100% attached to your loan until you pay it off (or refinance it). In some situations, a lender might release a co-signer if the business owner (and primary borrower) has seen a dramatic improvement in their creditworthiness, but this isn’t common.
Cosigner’s Impact on Business Loan Applications
A co-signer serves to decrease the amount of risk your lender has to take. This is due to the lender’s ability to now collect from two individuals if the business loan were to default. The lender will be able to collect from both you and your cosigner personally because the loan, in almost all cases, will require a personal guarantee.
Once a cosigner is brought into the loan application, then the loan provider will have to analyze the loan differently than they would if you were applying by yourself. There is no set way that a loan provider must do this, but it generally happens one in of three ways:
1. Weighted Average Method
The weighted average method is primarily focused on the credit scores of the business owners. Non-owners, even if they co-sign the loan, get very little consideration. The loan provider will look at each owner’s credit score and weigh it according to their stake in the business (the larger your stake, the more important your credit score will be). The cosigner’s credit, in this case, has little or nothing to do with the approval decision. The cosigner is only helping the application if they are able to pledge collateral.
2. Non-Weighted Average Method
The loan provider can also take the average of the cosigner’s credit score and the owner’s credit score, regardless of what the ownership amounts are. This gives the cosigner’s credit a larger role than in the weighted average model, but it’s still just a moderate impact on the total loan application. Combine this credit consideration with some collateral from the cosigner and it becomes more significant, improving your chances at getting approved for the loan amount you want.
3. Best Credit Method
Under this scenario, the loan provider will only consider the best credit profile between the borrower and the cosigner. If you have bad credit, then finding a lender who uses the best credit method would be ideal because you’re they’re relying entirely on your cosigner’s credit score.
The non-weighted average method is the most beneficial to you when you get a cosigner, and while it’s used more often for business loans than personal loans, you still shouldn’t bank on it. It’s a good idea to ask your loan provider how they analyze a loan application with a cosigner, before you ask someone to cosign your loan. You probably don’t want to ask someone to cosign your loan if your loan provider uses the weighted average method, because it may not help you at all. Instead, it just puts their assets at risk.
When You Should Get a Business Loan Cosigner
Waiting on your loan provider to demand a cosigner for your loan application to be truly considered is not the only time to get one. In fact, if you’re a less than prime borrower it’s a good idea to be more strategic about it. You should be thinking about how it may benefit you, and whether or not it’s worth it, before the lender asks. There are typically three reasons to get a business loan cosigner:
1. Increase the Creditworthiness of Your Loan Application
If your credit score is under 650, and you’re applying for a traditional small business loan, you should consider looking at a cosigner as an opportunity to improve your approval chances. Additionally, finding someone to cosign who has good credit can take awhile. The cosigner will often need time to consider the request and may need a spouse or adviser to weigh in as well.
2. Qualify for Larger Financing Amounts
You may find yourself barely meeting the minimum qualification requirements for your loan provider. Not only does this not guarantee your approval, but it also means if you do get approved your loan amount will be on the lower side of the lending range for your provider.
So, if you borrow between $5K and $100K, barely meeting the minimum requirements pretty much ensures that you’ll be approved for the lower half of the range at best (less than $50K). But, typically you’ll get even less than that, if you’re approved at all.
Understanding this means you can be proactive with your loan application. You can go out and find a cosigner, before you apply, to show the loan provider you’re worth the risk of lending you more money than they typically would to someone with your credit history. It increases your approval chances and increases the amount you’re likely to qualify for.
3. Prevent the Need for Collateral
Most traditional banks are going to want some type of collateral to secure a business loan, even if you’re a great borrower. However, finding a cosigner can sometimes allow you to convince the loan provider that you don’t need to put up real collateral because their risk is lower.
If both you and your cosigner are good borrowers, then this could be a good way to prevent pledging specific collateral at closing, and possibly leaving it open for additional financing later. This would require both of you to sign personal guarantees, and likely would not work for larger loans.
Alternatives to Getting a Business Loan Cosigner
Having bad credit, and not being able to secure a cosigner can severely limit your options. It doesn’t mean you’re out of options, though. If you can’t find a cosigner, or aren’t wanting to risk someone else’s assets, you can try these two alternatives:
Improve Your Credit
You can look at getting help to repair your credit and put yourself on a path to getting a loan in the future. If you’re not needing money right away, then this could be the best option. It’s always a good idea to do what you can to have the best credit possible regardless of your financing needs. If your credit is lower than you want it to be, then you typically fall into one of two areas:
- Credit Repair Needed: You may need help removing errors on your credit report or paying down debt. It’s important to get your utilization ratio down to under 33%
- Build Credit History: If your credit is thin you likely need to open new accounts to establish credit. You can do this by opening secured credit cards, fuel cards, or small business credit cards.
If you know you’ll need money in the future then you should prepare now by repairing your credit and improving your chances at getting approved. If you’re interested, take a look at our recommended credit repair companies.
Bad Credit Business Loan
If you need financing now, then repairing your credit won’t help immediately (but it is still recommended for your long term business plan). Instead, you need to find a loan that you can qualify for with your current credit profile. In that case, a bad credit business loan may help. These loans typically:
- Are More Expensive: These loans are more expensive than traditional loans, with higher interest rates and shorter terms than traditional financing (30-80% APR).
- Don’t Require A Cosigner or Collateral: They are easier to get, often not requiring a cosigner or collateral.
- Leverage Recent Results: You can leverage recent revenue, your receivables, or consistent credit card sales.
- Go Up to $500K: While many bad credit business loan borrowers get loans for less than $100K, you can get approved for amounts as high as $500K.
The qualification requirements vary, but you should expect to have a credit score of 500+. You can check your credit score for free here, and then check out our recommended bad credit business loan providers, like OnDeck.
What a Business Loan Cosigner Needs to Know
Getting a loan cosigner can be very helpful and it’s a frequent practice. Iin fact, 1 in 6 of all U.S. adults have cosigned a loan (either personal or business) for someone they know. But, if you’re the one looking to be a cosigner for someone else’s loan, then there are some things you should be aware of before you jump in. First of all, being a cosigner is risky. According to a recent study (analyzing cosigners for all loans, personal and business):
- 28% of cosigners see a drop in their personal credit scores because the primary borrower paid late, or they didn’t pay at all
- 38% of cosigners ended up having to pay some or all of the loan payments
- 26% of cosigners say that the total experience damaged the relationship with the person they cosigned for.
Here’s a list of the most important things co-signers should consider before saying yes to a borrower:
Promise to Repay
A cosigner is making a promise to repay the loan if the borrower defaults. This means you could be the hook for a large amount of money, or your personal assets could be on the hook if the borrower defaults and you can make the payments.
No Bank Notification of Default is Required
A financing provider doesn’t have to tell you if the borrower defaults, although it’s in their best interest to notify you. However, you could find out for the first time when a collection agency comes to you for collection of the debt. This could hurt your credit without your knowledge.
Collateral Typically Required by Cosigner
It’s normal practice on a business loan application for a cosigner to be required to provide collateral, which can be sold in the event of a default.
Cosigner’s Credit Will be Checked
A cosigner’s credit will be checked during the due diligence stage of the loan application, and each cosigner will be responsible for providing a personal financial statement.
Might be Responsible for Additional Fees
A cosigner is also responsible to pay late charges, fines, and penalties above the loan obligation, if the borrower fails to do so.
It’s important to know these risks going in, before you agree to sign up. Don’t be a cosigner for someone who is a risk to not pay the loan back, because it could damage your credit. And don’t be a cosigner just because you care about the person asking. Instead, approach it like a business decision, and do your own due diligence before saying yes.
Getting someone to be your business loan cosigner has it’s benefits, such as improving your approval chances or increasing how big of a loan you can take out. However, there is a lot of risk to the cosigner. Before seeking a cosigner, check your credit score for free and see if a small improvement or larger down payment might eliminate the need.
If getting a cosigner seems too risky or is unappealing, consider working with an alternative lender, like OnDeck. You can fill out an online application in 10 minutes, be approved for up to $500K today, and fully funded within 1-3 business days.