When you co-sign on a loan you are equally liable (along with the primary borrower) to repay the loan.
I hear this all the time:
“But Patrick, I was just the co-signer, why is this hurting my credit score?”
“I never even drove that car, all I did was co-sign!”
“I was just trying to be helpful and now this is hurting my credit report!”
A common co-signing situation is when a parent helps out a child by co-signing in order for a loan to be approved. Keep in mind that this debt will appear on the credit report and will have the same ramifications as if it were your debt exclusively. This means that in the debt-to-income ratio for qualifying (a calculation of monthly debt obligations found on the credit report and the gross monthly income) any debts you co-sign on will generally be counted as a liability. This could result in qualifying for less than what you are seeking, all because you co-signed for someone else. A good debt-to-income ratio would be anything under 45% of the gross monthly income. Also consider the payment ramifications, if you have co-signed for someone and they are 30 days late on the payment, it will hurt both of your credit scores. I have had many shocked and surprised parents in my office that cannot believe little Johnny or Sally was late on a loan they co-signed for.
Another cause for concern is co-signing on a credit card. Not only is there the risk of a late payment, but there should also be major concern for the balance on the card. If the card is maxed out, there will be a negative impact on credit scores. There is a certain unknown anytime you co-sign with someone. The only true precaution that can be taken (other than declining to co-sign) is to pay the bill yourself each month. It is a good thing to help your children get established in the world of credit. However, it is equally important to protect yourself.
If you do decide to co-sign, take the risk out of it by collecting the payment from the party that needed you in the first place and pay it yourself. The best way to do this is to have them write a check out directly to the lender and you mail it out yourself. This is especially helpful when you are trying to qualify for a new mortgage. If you can prove that full payment for the debt is coming from the other party’s checking account, you may be able to exclude the monthly debt when qualifying for a mortgage. Depending on the size of the debt it could make a difference. Whereas if you receive the payment from the other party and then write a check yourself then it would appear that the other party is not solely responsible for the payment of the debt. By making sure the payment is going out each month you can rest assured there will not be a surprise the next time you are sitting in a lender’s office applying for a loan. The only risk you would run at this point would be if the check were to bounce. At least under those circumstances you would still be well within 30 days of the due date to make the payment yourself if the other party was unable to make payment. When it comes to protecting our credit, co-signing is one of the biggest breaches of our safety out there. We assume the other person is making the payments when they are due, but can you really be sure?
When it comes to money, people make extraordinarily peculiar decisions at times. Why set yourself up to be a part of that type of uncertainty? People lose their jobs, become incapacitated, or have some other life altering event; the list of possibilities is endless. Guard your name and your finances carefully.
About the Author: Patrick Ritchie loves teaching about credit; he is the author of The Credit Road Trip and The Credit Road Map series of books. Check out his free online classes at www.CreditLiteracyProject.com.
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