This article is part of a larger series on Business Financing.
A business loan cosigner is a person willing to give a lender a personal guarantee that they’ll repay your loan in full if you fail to make the payments. This increases the chance that your loan will be approved, especially if you don’t have strong credit or enough collateral to obtain business financing.
You should consider using a cosigner when there’s a deficiency in your qualifications that a cosigner can help overcome. These primary borrower deficiencies could include:
- Inadequate income
- Too much debt (personal or business)
- Poor repayment history
- Limited credit history
- Not enough time in business
There are risks, especially for the cosigner. Before you consider using a cosigner, you might consider an easy business loan from National Funding. As long as you have a credit score of at least 600, at least six months in business, and at least $250,000 in annual revenue, you can qualify for up to $500,000 in less than 24 hours. Visit National Funding’s website for more information.
How Using a Business Loan Cosigner Works
When considering qualifications for a business loan or a personal loan for business use, the lender will calculate the borrower’s ability to repay the loan. With a startup business, the lender will consider the owner’s personal credit and payment history as part of a personal guarantee. If the individual has poor credit, lack of income, or a high debt-to-income (DTI) ratio, the bank may ask for a cosigner. This person will add a personal guarantee to the loan for added security.
The cosigner will have their personal credit and income considered to make sure they’re an adequate cosigner. As long as the primary borrower pays the loan as promised, the cosigner won’t be required to do anything after signing for the loan. However, if payments are late or the loan goes into default, the bank or a debt collector will notify the cosigner so that they can collect funds.
Note: Not every state requires the lender to seek repayment first from the business owner and primary borrower. The lender can, in many states, go directly to the cosigner for payment.
A cosigner might not necessarily guarantee a better interest rate on the loan. This rate may still be based on the primary borrower’s credit. Using a cosigner might keep you from having to use collateral to secure the loan, but that will vary from lender to lender.
Pros and Cons for the Borrower When Using a Cosigner
|Better chance of getting loan approved||Higher loan amount may be more than your business can afford|
|Lower interest rates and better terms||Late payments or defaulted loan could hurt the credit of you and your cosigners|
|Could qualify for a larger loan amount||Could damage personal relationship if the loan goes into default|
|Could reduce the chance of needing collateral||You might end up needing collateral anyway|
Using a cosigner can help you get a loan approved that might otherwise be declined due to poor credit or lack of income. You might get a lower interest rate, you could qualify for a larger loan amount, and you might not have to use collateral to secure the loan. However, none of those things are guaranteed with a cosigner.
One of the biggest risks to using a cosigner is obtaining a loan that’s larger than your capacity to repay. So even if you qualify for more money with a cosigner, be sure the monthly payment fits into your personal and business budget to ensure your ability to repay.
Other risks include damaged credit for you and the cosigner if there are late payments and a damaged personal or business relationship if you default and the cosigner is stuck with repaying the loan.
Risks for the Cosigner
The benefits for the cosigner in this arrangement are limited. A cosigner’s credit score will increase if the loan is paid as promised. You are also helping someone get much-needed funding for their business.
However, the risks involved with cosigning on a business loan can be significant:
- You are responsible for the loan: If the borrower cannot repay the loan, you’ll be responsible for it—the lender could even sue you.
- Your credit score can be damaged: Not only are you responsible if the borrower can’t pay the loan, but you’ll also see your credit score drop due to late payments.
- Your borrowing power can be limited: Whatever loans you cosign for count against your personal DTI ratio, so it might hurt your ability to get personal or business credit for yourself.
- You might be blindsided: Because cosigners don’t always receive communication when payments are late or a loan is close to going bad, you might have no idea until the loan is in default. By this point, your credit will likely have taken a significant hit.
- You might have to forfeit collateral: If you were required to provide additional collateral as the cosigner, the lender could repossess that collateral to help cover the costs of a bad loan.
- It could damage a personal relationship: Odds are that if the borrower stops paying and leaves you responsible for repaying a business loan, whatever relationship you had with that person will be permanently damaged.
Difference Between Cosigner and Coborrower
The primary difference between a cosigner and a coborrower, also known as a joint owner or joint applicant, is the level of investment in the loan. A cosigner is only required to repay a loan if the primary borrower doesn’t pay. However, a coborrower has the same repayment responsibility as the primary borrower.
In addition, if the loan is to purchase collateral, the coborrower would be a co-owner of the purchased collateral. A cosigner wouldn’t own the collateral, even if they had to pay off a loan in default.
Loans with coborrowers would likely receive better interest rates and larger loan amounts. They reflect less risk to the lender because both borrowers would be responsible for making payments on the loan.
Alternatives to Getting a Business Loan Cosigner
If you would like to avoid using a cosigner on future business loans, there are a couple of other options available:
- Improve your credit score: Whether you have low credit or a lack of credit, an improved credit score could keep you from needing a cosigner. Keep credit utilization low, and use small secured credit cards or small business credit cards to build your score.
- Consider a bad credit business loan: While bad credit business loans can come with higher interest rates and fees, they can also help you get needed funding without a cosigner. These loans can also help you improve your business and personal credit for future loans.
Using a business cosigner can help you get the business funding you need. A cosigner can help borrowers with poor credit, limited credit history, or insufficient income. There are risks involved, especially for the cosigner. If the risks outweigh the rewards, consider other types of financing.