If a friend or relative approaches you to co-sign on a loan, it’s important to consider the impacts that decision could have on your credit before you agree. Co-signing is more than just allowing your co-borrower to benefit from your help; it is a promise that you will pay back the loan if the co-borrower is unable to.
What are the risks?
When you become a co-signer, you’re 100% responsible to pay the loan if the other borrower stops paying. If your co-signer defaults, your credit score will be negatively affected.
Because the co-signed loan counts against your outstanding debts, it could negatively impact your ability to access additional credit for your own needs, especially if you have other outstanding balances. Even though you aren’t making the payments on the co-signed loan, the lender still views it as a potential financial obligation. This could result in a lower approval amount for your own needs because it appears as though you have less money leftover to afford additional loan payments.
Speaking of other outstanding balances, co-signing on a loan could impact your credit score if that loan makes your credit utilization go above 30%. In other words, if what you owe on your other loans and credit cards, plus the co-signed loan, is more than 30% of your total available credit, your score may go down.
And finally, if your co-borrower stops paying, and that negatively affects your credit score, it most certainly will also have a negative impact on your relationship.
Are there benefits?
Co-signing isn’t an automatic negative, particularly if you have a very high credit score, a long credit history, and low credit utilization. In that case, co-signing on a small installment loan might have a minimal effect on your score. But even if you have little or no credit history, or past negative marks on your credit report, as long as the loan is paid on time, that positive payment history will reflect well on your credit score.
Co-signing on a loan could also positively contribute to your credit mix – which is the combination of credit cards and installment loans (like auto, home and personal loans) you carry. If you only have a few open credit cards, and no installment loans, co-signing on an auto loan could help boost your credit score because your credit mix is better.
Co-signing best practices
Don’t assume you can just trust your co-borrower because you believe they would never act in a way that could negatively impact your credit. Life happens. People lose jobs and run into financial troubles. You must be prepared to take responsibility.
If you agree to co-sign on a loan, it is imperative to always ensure the lender has your most up to date contact infomration. This way you'll always be informed of any pertinent account information before you are negatively impacted. You'll also want to keep a close eye on the other borrower. That person should have no expectation of privacy, and you should not make any assumptions about how or if the loan is getting paid. As the co-signer, you have every right to request proof of payment each month – it could be as simple as a screen shot or forwarded payment confirmation email. Keep the lines of communication open and make sure your co-borrower understands they must inform you in advance if they won’t be able to make a payment. If you do not feel comfortable protecting yourself and your credit in this manner, then you should not (co-)sign on the dotted line.