Enough funding is necessary for every business across all industries. Otherwise, a company’s financial health and business future can be negatively impacted. That’s why those who need more funds seek external financing for their daily operations and long-term growth.
However, not every company can easily access funds. Reasons like being a start-up, using unconventional revenue models, unstable cash flow, bad credit score, and having no assets to use as collateral can get in the way of seeking financing.
Fortunately, these can be overcome with a cosigner. Here’s what you need to know:
What’s A “Cosigner”?
A cosigner is someone who guarantees the debt of another individual. Should they cosign (to sign jointly with a primary borrower for a loan), they’ll be financially and legally responsible for paying off the debt of a primary borrower whose account status is:
- Delinquent – happens when a borrower misses loan payments, even by one day.
- Default – happens when a borrower fails to make repayments as scheduled in the terms of their promissory note after missing several payments over a period.
The term cosigner can be interchanged with the word “guarantor.” However, they can sometimes have specific differences, especially about liability specific to state laws and financial institutions.
- Cosigners – individuals pay off a loan when it becomes delinquent
- Guarantors – individuals or groups of people (e.g., another company or government body like the Small Business Administration or SBA) who pay off a loan when it defaults
A cosigner is also different from a “co-borrower.” Although both are legally responsible for the loan being taken out by a primary borrower, a co-borrower is entitled to receive loan proceeds, while a cosigner is not.
When Is A Cosigner Needed?
A cosigner becomes necessary when a loan applicant or primary borrower doesn’t have a good score, sufficient credit history, income, or reliability, in general, to get the loan on his own.
By asking someone to be a cosigner, lenders receive extra assurance that they’ll be repaid, even though the primary borrower isn’t creditworthy. This is because the cosigner’s income and credit profile are considered in addition to the primary borrower, increasing the chance of loan approval and getting more favorable terms.
Can A Business Loan Be Cosigned?
A business loan can be cosigned. The cosigner will also have similar functions: be responsible for paying business loan repayments on behalf of the primary borrower, which is a company in this sense. They usually do so if the first guarantor can’t make the repayments.
The first guarantor can be the business owner. This usually happens in many new and small companies. Lenders often require them to be a “personal guarantee.” In other words, if the company fails to pay for its loan, they’re liable to pay for it using their personal funds or assets.
Other lenders may allow or require additional guarantors to add more security over the business loan. This is where cosigners come into play. As mentioned earlier, adding them in addition to guarantors can make a big difference between getting approved for the business loan and being rejected.
Loan Process of A Business Loan with a Cosigner
Applying for a business loan and having it cosigned is easy. It’s similar to applying for a personal loan, except more profiles and accounts will be assessed. Lenders must pull the cosigner’s credit, so inform them beforehand.
Here are the general steps on how to apply:
- Find a business loan lender who accepts a cosigner
- Find a willing and financially able cosigner, ideally with a good score and stable income
- Gather and accomplish documents as required by the lender
Since more profiles are involved, the loan process is longer. First, lenders will calculate a business’s, the primary borrower, creditworthiness. Most of the time, their financial health, credit score, financial standings, debt-to-income (DTI) ratio and regional trade risk will be assessed.
The business owner’s personal finance will be assessed, too, as part of the personal guarantee. This is especially necessary if the owner has poor income, not-so-stellar credit, and a high DTI ratio (meaning more money goes towards debt repayment, demonstrating an imbalance between debt and income).
Similar to personal guarantors, lenders will check the cosigners’ personal credit and income. The good news is that these checks won’t usually harm their records. They don’t have to do anything except for signing the loan papers.
A cosigned business loan can help a company get lower interest rates and better terms. However, it shouldn’t be taken lightly. Should the loan default or, worse, become delinquent, it may harm a cosigner’s present and future finances.
Additionally, note that just because a company needs a business loan this time around doesn’t mean it’ll be the same case next time. If they repay their loan responsibly, they might improve their credit enough to fly solo for their next big loan.