How to be a co-signer without wrecking your credit
By Allie Johnson
November 16, 2015
It's a tricky situation: Your loved one reveals money problems and asks you to co-sign on an auto loan, credit card or even a mortgage. You want to help, but worry you'll end up shouldering the burden of payments and put your credit at risk.
Co-signing is risky, but there are steps you can take to keep your good credit while helping someone else build theirs, says Denise Winston, a financial expert with a background in banking and the author of “It's Your Money – Avoid Costly Mistakes.”
The stakes are high for the co-signer, who agrees in writing to pay a loan back if the borrower fails to do so. Both names go on the account, which shows up on both the borrower's and the co-signer's credit reports. If the borrower pays late or stops making payments, the co-signer can suffer serious credit damage from negative marks such as late payments and collections. When the co-signer learns of the problem, he or she is supposed to take over payments, but some damage likely has already been done.
“If you do co-sign, go into it with your eyes wide open,” Winston says. “This is not a small decision to make.”
Here are nine steps to protect yourself as a co-signer:
- Have a serious talk. First, find out why your friend or relative needs a co-signer, says Wayne Sanford, credit expert and owner of credit consulting company New Start Financial. Is it because she has bad credit, not enough income or is just starting out? In some cases, she might not need a co-signer, says Sanford. For example, your 18-year-old son probably can get his first car loan on his own, albeit with a higher interest rate than he'd pay if Mom or Dad signed on. He'll have to have a nice-size down payment and proof of income, though. Down the road, he can refinance to a better rate, Sanford says. If you do agree to co-sign, explain that your loved one's failure to make on-time payments could ruin your ability to buy a car, rent an apartment or get a job in the future, Winston says. “They need to understand what you're putting on the line,” she says.
- Check the borrower's credit. Since you need to go into co-signing with your eyes open, take a peek at your loved one's credit. The friend or relative asking you to co-sign can pull his reports for free at AnnualCreditReport.com. Look for late payments, collections, judgments and other negative marks to assess the person's financial situation and to make sure you've been told the truth about his history. There's a difference between co-signing for the uncle who was late paying bills for a few months because he was out of work after back surgery vs. the financially irresponsible cousin who's always sponging off everyone, Sanford says. “Know who you're co-signing for,” he says.
- Think about your own money plans. Planning to apply for a credit card, buy a car or refinance your house soon? Even if the person you co-sign for makes all payments on time, co-signing for a loan could affect your ability to get credit because the co-signed loan also appears on your credit report, affecting your debt-to-income ratio, Winston says. If the co-signed loan pushes that ratio over 40 percent, your loan application could get denied, she says. “Co-signing could put a screeching halt to some of your financial plans,” she says.
- Consider the worst-case scenario. “You need to understand you are signing a legally binding contract that says, ‘If the borrower does not pay the bill, I will pay it,'” Sanford says. If the borrower gets sick, loses his job or just drives off into the sunset in that new car he got with the auto loan you co-signed, could you comfortably take on the payments until the loan is paid off to keep your own credit from tanking if the loan would otherwise go into default?
- Lower your risk. If you can't afford or don't want to put yourself on the hook for a large sum of money, but you still want to help, consider making a counteroffer. For example, if your brother's car breaks down and he asks you to co-sign a loan for a new $25,000 ride, you can say no but offer to co-sign on a $5,000 loan for a decent used car. Or, if your daughter asks you to co-sign on a credit card, you could decline but offer to add her as an authorized user to your low-limit card. It's smart to limit your risk to an amount you can comfortably take on, Sanford says.
- Spell it out in writing. If you agree to co-sign, hammer out a written agreement, Winston says. Get the borrower to promise in writing that if ever unable to make a payment, he or she will notify you ahead of time. Also agree on consequences if payments cannot be made – for example, on a car loan, that you would get possession of the car. Also consider using collateral (for example, your daughter temporarily hands over the ring she inherited from grandma) or adding some kind of promise as leverage, Winston says. She knows of one mom who made her adult child agree not to get any more tattoos until a co-signed loan was paid off, she says. “You can get creative,” she says.
- Don't count on a future escape. Some co-signers hope to get taken off a loan down the road, but it's very difficult to do so, according to TransUnion, one of the three major credit bureaus. In fact, a 2015 Consumer Financial Protection Bureau report found that more than 90 percent of private student loan borrowers who applied for a co-signer release were denied. However, it can't hurt to ask if the lender offers an escape hatch for the co-signer after, say, 12, 24 or 36 consecutive on-time payments. “Definitely check into it, but you'd better get it in writing,” Winston says.
- Consider taking control from the start. When you co-sign, you're taking 100 percent of the risk, but you lack total control of the account, Sanford says. Instead, weigh taking the loan as the primary borrower and making your loved one the secondary borrower. Have the statements sent to you and pay the bill yourself so you control when and how it gets paid, he says. Have your loved one pay you back each month by check or money order and keep copies of their payments for your records.
- Monitor the loan closely. I you're relying on the borrower to make regular, on-time payments to the lender, it's crucial to stay on top of the loan to avoid having your credit damaged before you learn of a problem. Get online access to the account and set up email or text notifications for both you and the person for whom you co-signed, so you each get an alert when the payment is due and when it posts, Winston says. As a backup, you can ask the lender to notify you, in writing, if a payment is missed, according to the Federal Trade Commission. Also, watch your own credit carefully to make sure nothing is amiss with the loan, TransUnion recommends.
If you do co-sign, go into it with your eyes wide open. This is not a small decision to make.”
— Denise Winston,
a financial expert and the author of “It's Your Money – Avoid Costly Mistakes.”
You need to understand you are signing a legally binding contract that says, ‘If the borrower does not pay the bill, I will pay it.'”
— Wayne Sanford,
credit expert and owner of credit consulting company New Start Financial
You should always go into co-signing expecting things to go wrong and, if they don't, you might be pleasantly surprised. “Co-signing works out plenty of times,” Sanford says.