Those of you who follow my writings, blogs, vlogs, and speaking engagements know I rarely give my personal opinions about credit-related issues. Whether it’s credit repair companies, lending practices, debt collectors, credit reporting agencies, or credit scoring systems, I tend to be Switzerland (neutral) on the topic. I’m going to make an exception to that rule as I answer the question, is co-signing for a loan a good idea?
There may come a time in your life when someone asks you to co-sign on a loan or other credit obligation. Whether that person is your child, another family member, or a friend, it’s best to decline the request. In most cases, you should even avoid co-signing for your spouse (and vice versa) unless the two of you are trying to take out a mortgage or other large loan and you need both of your incomes to qualify. You’re probably wondering why I take such a positioned stance on co-signing. The answers will follow.
What is co-signing?
Co-signing is the act of including your name and credit reputation to someone else’s credit application. If someone’s credit score or income is insufficient to qualify for a loan or credit card on their own, the lender may give that person the option to add a co-signer to strengthen the loan application.
When you co-sign for someone else, you are equally responsible for the debt—just as if you were the primary borrower. In fact, there really is no such thing as “co” signing…there’s “also” signing because that’s exactly what you’re doing. The downside, of course, is if either of you fail to repay the credit obligation as promised, the lender can come after both of you and even sue you for the defaulted debt.
Being a co-signer means you’re taking a risk that the lender wasn’t willing to take. The lender’s review of the individual (pre-co-signing) credit application indicated that there was too high of a risk that the borrower wouldn’t be able to repay the money as promised. In other words, they have bad credit, no credit, or not enough income to take on the new credit obligation.
How does co-signing impact your credit?
When you co-sign for someone else, the account will almost always show up on your credit report because it’s your account too. Once the account appears on your credit reports it will impact your credit scores. That impact can be positive or negative. There is no allowance given by credit scoring systems to co-signed accounts. They are considered the exact same way as individual accounts.
In some cases, co-signing could hurt you even if you never missed a payment. With credit cards, for example, a high credit utilization ratio (the relationship between your credit card balances and limits) can be bad for your credit scores. And, if you’ve co-signed for a large loan with a large monthly payment, that payment will increase your debt-to-income ratio and might preclude you from qualifying for your own loan because the lender considers you to be too financially leveraged. The debt-to-income ratio is the sum of your monthly payment obligations divided by your gross monthly income. Typically, and it varies, you need to be below 43% in order to qualify for a mortgage loan.
In the event the co-signed loan is paid late, you could face serious credit problems. As a co-signer the late payments will appear on your credit reports. And, unfortunately, they could send your credit scores crashing.
And if a co-signed debt goes into default, well then things are going to go from bad to worse. If a default occurs a collection account might be added to your credit reports and could potentially inflict more damage on your credit scores. To make matters worse, the damage from a poorly managed credit obligation can last for years, even as a co-signer. Late payments and collection accounts can both remain on your credit report for up to seven years according to the Fair Credit Reporting Act.
How to respond when someone asks you to co-sign
Repeat after me….”No.” Instead of co-signing you could consider trying to help your friend or family member to build their credit in other ways. For example, adding your family member or friend to your credit card account as an authorized user might be beneficial. If the account is well-managed and shows up on your loved one’s credit report, it has the potential to help them establish positive credit history.
I don’t take this extreme position because of personal experience. I take it because I have heard from countless consumers over the last 30 years telling stories about co-signing disasters and regret. When it comes to your credit, it’s best to remember that it’s YOUR credit and not something that you want to put at risk simply because a bank, card issuer, student loan lender, or apartment complex won’t do business with one of your friends or relatives.
