Do You Really Know What It Means to Co-sign?
With good credit comes great responsibility, and leveraging your history to help a family member, friend or business partner obtain a credit card or loan approval is an excellent example. Before you decide to co-sign on the proverbial dotted line, it is important to understand exactly what you’re getting into.
In most cases, the would-be borrower needs a co-signer because, on their own, they represent too great a risk for the prospective creditor. They may be young, with a slender credit history, or their report may be marred by negative factors such as late payments, charge-offs, bankruptcies or vehicle repossessions. By asking you to co-sign, they are essentially asking to borrow your good credit history. You are telling the lender that you agree to pay them yourself if the primary borrower defaults.
Benefits of Having a Co-Signer on Your Car Loan
Before we list the inherent risks, let’s look at three benefits of co-signing:
1. You Can Do Someone a Favor.
A common co-signing scenario involves a parent or grandparent helping their child or grandchild obtain a student, auto or home loan, perhaps on more favorable terms than they could qualify for on their own. This is a meaningful gesture that won’t soon be forgotten and, if the loan is paid as agreed, won’t cost the co-signer a dime.
2. You Can Diversify Your Accounts.
Creditors tend to prefer borrowers with a mix of installment credit loans and revolving credit accounts. If your report only contains credit cards, co-signing on an installment loan can boost your credit standing by demonstrating that you are capable of managing multiple account types without any issues.
3. You Can Increase Your Available Credit.
Co-signing for credit cards can improve your score by increasing your amount of available credit — a crucial factor in determining creditworthiness. As long as the primary owner of the card uses it responsibility, your credit score will reflect that.
Co-signing a loan can also have a negative impact on your credit score. Here are a few things to keep in mind:
How Having a Co-signer Can Impact Your Credit Score
1. You Can Get Dinged by Late Payments and Defaults.
If your friend or family member misses a single payment or lets an installment loan go into default, you will take the hit right along with them. The lender will make you responsible for the unpaid balance and, worse yet, you won’t enjoy the use of the borrower’s purchases, education, vehicle or home. By co-signing, you agree to share the financial responsibility, not the ownership, of the property or account.
Remember, late payments are one of the fastest ways to tank your credit score, and one of the easiest to avoid. But co-signing for someone else takes those decisions out of your hands.
2. You Can Tank Your Debt to Credit Ratio.
Yes, increasing your available credit was also one of the potential benefits. But if the primary owner of a credit card for which you co-signed runs up the balance, your credit score will be negatively affected. Debt to credit ratio is a key component of your score. It takes into account how much credit you qualify for and the amount you actually use. You want to maintain a much higher percentage of credit than debt, and co-signing for a loan can tip that balance in the wrong direction.
3. Outstanding Loans Can Hold You Back.
Co-signing for an installment loan might make it more difficult to get approved for a loan of your own down the line. For example, if you co-sign for a mortgage, it could affect your chances of obtaining another mortgage for yourself — even if the primary borrower has been making their payments on time and without issue. You could be denied on the basis that you already have financial responsibility for a home and your income can’t support two mortgage payments.
There are countless reasons a co-signing scenario can go wrong, but only one guaranteed result: You will be held responsible, and your relationship with the primary borrower will sour. So if you decide to go through with it, hope for the best and be prepared for the worst.