Has a loved one ever asked you to do a big favor? If you are like a lot of people then you probably want to do anything within your power to help out the people who are important to you. Co-signing, however, is much more than just a simple favor. Instead co-signing is a ticking time bomb just waiting to destroy your credit scores and to cause you potentially serious financial problems.
What Really Happens When You Co-Sign
The act of co-signing is misunderstood by many, perhaps even most, consumers. When you co-sign for a friend or family member what you are actually doing is accepting full liability for the debt in the event that the other borrower fails to pay. Co-signing means that you agree to pay the full amount of the debt if your friend or family member does not hold up their end of the bargain.
When Co-Signing Goes Wrong
Banks require co-signers for one simple reason. They do not have enough confidence in the applicant to lend that person money based upon his/her credit history. In other words, the bank feels like loaning money to the applicant is too risky, thus the requirement for a co-signer. When you agree to co-sign for someone else you are essentially taking a risk which a lender already thinks is unwise.
Co-Signing Gone Wrong can:
1. Destroy Your Credit
Co-signing will almost always damage your credit scores even under the best of circumstances. In fact your good credit is at risk for at least some degree of damage even if your loved one makes every single payment on time. Merely applying for credit as a co-signer may have a slightly damaging effect upon your credit scores (the inquiry) and the new account itself can make your average age of credit younger and, thereby, hurt your scores yet again.
When you co-sign for a credit card (perhaps the most dangerous type of account for a co-signer) you are putting your credit scores at extreme risk month after month. If you co-sign for a credit card and the primary card holder makes a habit of revolving a balance on the credit card account your scores could take a major hit even if every single monthly payment is made on time. The worst case scenario with co-signing occurs when your loved one makes late payments or fails to pay at all. When late payments (or worse) start to show up on your credit reports your once great credit scores can quickly be destroyed.
2. Land You In the Middle of a Lawsuit
As mentioned above, when you co-sign you are accepting full legal liability for the debt. If the primary account holder fails to pay as agreed the lender will actually most likely come after you first in the event they decide to sue over the defaulted debt. Even wage garnishment is an option which creditors may sometimes decide to pursue if the court will allow.
3. Ruin Your Relationship with a Family Member or Friend
One of the biggest and most overlooked risks associated with co-signing comes in the form of the damage which co-signing can cause to your relationships. Think of how you would feel when and if your friend or family member fails to keep their word and does not pay your new joint debt as agreed. Even in your loved one makes late payments due to an understandable reason (job loss, illness, etc.), you could still harbor some very resentful feelings toward that person if their actions trash your previously good credit and make it impossible for you to qualify for a loan or perhaps a job in the future.
An Alternative Way to Help
As you can see co-signing for someone else is truly a horrible idea. You should always say no whenever a loved one asks you for this particular favor. Period. However, just because you have to say no to co-signing in order to protect your credit that does not mean that you cannot help out your loved one in another way.
If you want to find an alternative way to help out a friend or family member then you might consider adding your loved one as an authorized user to one of your existing credit card accounts. As long as the account has a low balance and a great payment history (no late payments) then you might be able to help your loved one build some credit by adding him/her as an authorized user. Authorized user accounts will generally be reported to the credit bureaus, potentially boosting your loved one’s credit rating. If your loved one will couple your authorized user account with some positive accounts of his/her own and perhaps with some professional credit repair assistance (if needed) then a co-signer might not even be necessary in the future.