Many Americans may have undergone significant financial difficulties during the recent economic downturn that could have put even a good credit score in a troubling position. As such, even a few years later, it may be possible that some do not have the ability to obtain a particular line of credit on their own.
In these cases, many consumers who do not have a credit standing strong enough to get the kind of financing they may be seeking might turn to relatives or friends to help them out. However, if you are someone who has managed your accounts responsibly in the past few years and have a credit score strong enough to cosign for a friend or family member, doing so might not always be the best idea.
Why you should approach with caution
The idea of cosigning on another person's line of credit can seem like a good one. Whether you might be helping your brother obtain a car loan or letting your kids have credit cards they can use when they go off to college, you would be undertaking a massive responsibility and financial risk in doing so.
There are many ways in which a decision to cosign can have a negative impact on your credit standing.
Take the example of doing so on your brother's auto loan, for instance. By cosigning, what you are essentially saying to the lender is that you are agreeing to be just as responsible for the payments as your brother. That may not be the arrangement you have worked out with your brother, of course, as your expectation might be that it's solely his job. However, one missed payment and the lender certainly won't see it that way. Because cosigners are considered to be in the same boat, so to speak, the missteps of one will reflect equally on the other.
So if your brother misses a payment on that car loan, your credit score will necessarily drop. Depending on how high your score is, it could potentially take more than 100 points away from you, even though you didn't personally do anything wrong.
The other example
In the case of a cosigned credit card, there may be even more risk, particularly if the borrower is as inexperienced in dealing with debt. Taking on this type of responsibility may be helpful to any young person as they prepare to move into a world of financial freedom, but as with the car loan above, doing so can carry significant problems if things go awry.
For one thing, there is obviously the continued issue that a late payment can take a massive chunk out of your credit score, but beyond that there are other concerns as well. For one thing, debts held on credit cards are considered to be part of what is known as "credit utilization ratio," which essentially means the amount of money owed to lenders as a percentage of your total available limits. When calculating this, contrary to what is a common misperception, the less a borrower owes, the better off his or her standing will be.
At first, cosigning on another person's credit card can be beneficial because that account will be using 0 percent of available credit, even though the limit may be a few thousand dollars. For instance, let's say the card's maximum is $2,000, and you already had $4,000 in debts on three cards with total combined limits of $10,000. You may still be carrying the same amount of debt, but your limits have increased, cutting the percentage from 40 percent to 33 percent. However, depending on how the other person on the account handles the card, your ratio could increase significantly in a relatively short period of time, even if you haven't done any spending of your own on it.
Again, you are considered to be equally responsible for the balances on any cosigned balance, rather than being on the hook for 50 percent of it. If the balance on such a card is $1,000, that's $1,000 added to your credit history, not $500.
For these reasons, it might be wise to have a serious talk and do some math before you cosign on anyone's new line of credit, no matter who they are. If you don't, you might end up being responsible for late payments and balances you never thought you'd have to worry about, and that can do significant damage to your credit standing and overall finances.
Before you undertake this or any other credit-related decision, you might also want to take the time to check your credit reports for any unfair markings which may be adversely affecting your standing. If any are discovered, it may be wise to contact a credit repair law firm to try to sort out the situation as quickly as possible.