How Does Co-Signing A Loan Affect Your Credit?

Co-signing can affect your credit both positively or negatively because it is reported in your credit report as “your loan”. In this post, we will explain the how and why it affects your score, as well as other relevant issues. Below is a brief “table of contents” on how we will address co-signing questions.

Table of Contents

1. How Cosigning Can Positively Affect Your Credit?
2. How Cosigning Can Negatively Affect Your Credit?
3. How To Set Up Arrangements With Co-signee to help protect your credit?
4. Understanding Implications of Co-signing
5. Understanding Federal Rules for co-signers?
6. FTC’s Suggestions For Questions To Creditors and Precautionary Measures
7. Questions You Should Ask About Co-signees

How Co-signing can positively affect your credit? – Because co-signing a loan (whether it be a student loan, car loan or mortgage) is reported in your credit report², it can actually positively affect your credit (assuming the co-signee fulfills his or her obligation and pays on time all the time).

How? Because co-signing appears on your credit report as if “you took” the loan, you get the benefits of it. For example, co-signing for a revolving credit like credit cards increases your “credit availability”. And if the co-signee uses that credit availability sparingly, then you get the benefits of “increased credit utilization ratio”.

Co-signing for someone could also potentially increase your “mix of credit” and your credit score could potentially increase because of the better credit mix. For example, co-signing for a car loan when all you have are credit card reporting to your credit report increase your “credit mix”.

If the co-signee pays on time, you also get the full benefits of that.

How co-signing can negatively impact your credit? – Co-signing can negatively impact your credit score in two ways. Just can it can improve your credit utilization ratio, a co-signee who max out his or credit limit on a revolving credit like credit cards can hurt your credit utilization ratio (and potentially your score).

But the area where it really hurts is if the co-signee pays late. That is the biggest worry for a co-signer because late payments do hurt your credit score.

How To Prevent Late Payments – Arrangement With Co-Signee – One way to prevent co-signees late payment from affecting your credit is to actually pay the loan yourself. And then get the co-signee to pay you.

For example, you co-sign a credit card for your son or daughter. Instead letting him or her pay the credit card issuer directly, you pay the credit card issuer instead. You then ‘collect the bill” from your child. That way, if he or she is late, the payment is still on time because it is paid by you. You then deal with your child (the co-signee) directly. Your credit score will then not be affect if your child has the occasional payment problems.

The key for this arrangement to work is to make sure you have the financial capability to pay for the co-signee in case they face financial difficulties. Because if you have problems paying the bill if the co-signee has problems, then that is not going to help the situation.

Understanding Implications of Co-Signing – If you co-sign a loan for someone, you are liable for the debt^1,2. That means that if the co-signee does not pay, you are liable for the full amount. You could also be liable for late fees and interest charges. In certain states, creditors can come after you for payments before they approach the co-signee.

Because you are liable as a co-signer, the loan you co-sign is reported to the credit bureaus as though it is yours (even though you get no “tangible benefit or service”)^1,2.

Federal Law and Co-signers – Under the guidelines of the Credit Practices Rule³, banks and financial institutions have to give you a notice that explains your obligation as a co-signer BEFORE you co-sign the loan. According to the FTC, this is a typical language:

FTC’s Suggestions For Questions To Creditors and Precautionary Measures – The FTC has the following suggestions for potential co-signers that might help you in the event that the co-signee is unable to pay the loan.

Questions You Should Ask About Co-signees – Before making the decision, ask yourself the follow questions:

•  Can I afford to make this payment if they default? To save your own credit, you will need to make the payment on the co-signed loan as well as continue to pay for your own obligations.

• Is there any chance at all that they will default on this loan? Could they lose their job?
• How will the new loan affect my credit score? Not only can a default hurt your credit, but having too many loans or accounts on your credit can harm it as well. An additional loan, even though it isn’t yours, could appear as though you are overextended.
• Is there anything that I am going to want to borrow money for in the near future? How will this loan affect that? Much like the previous question, if it appears that you are already overextended in credit, it may hurt your chances in the future for loans that you may need yourself.

Remember also that co-signers can be sued in court, just like the person who took out the loan in the first place. In fact, if you co-sign for someone, and they are late on their payment, lenders have the right to call you to collect the money, garnish wages, and seize property. Unfortunately, once you co-sign, you cannot just ask to have your name removed from the account if things go badly.

The last thing to consider is that co-signing on a loan for your friend or family member may not actually help them in the long run. Although it will help them now by securing the loan for a house or credit card, statistically, when people have poor credit and the banks see a co-signer for a loan, they are more likely to ask that person to get a co-signer again. By helping them out now, you could actually be making it more difficult for them (and you) to obtain loans in the future.

Whatever you decide, do not feel badly. Just be informed. If you go into a co-signing situation, be aware and prepare yourself for the risks that are involved. It is possible that co-signing can result in a winning situation. If you are unprepared, you run the risk of losing your own good credit history and owing the money that the other person borrowed.

Considering that on average 3 out 4 people that co-sign on a loan end up paying it themselves, one would think that consumers would be extremely cautious when making this type of decision. Oftentimes it is against our better judgment that we sign our names on another person’s loan, but yet it is natural to want to assist a family member or close friend by helping them secure a loan and hopefully repair or build their own credit scores. Depending on the person and the circumstances, choosing to be a co-signer on a debt is not always the wisest decision.

References
1. FTC: Co-signing a lona
2. Experian Forum: Being a co-signer can help your credit
3. Federal Reserve Board: Staff Guidelines on Credit Practices Rules