The Ultimate Guide to Cosigning and Your Credit: Everything You Need to Know

Disclaimer: We are not qualified legal or tax professionals and do not give advice. Always speak with a qualified professional before making any legal or financial decisions.

Are you considering cosigning a loan or credit card for a friend or family member? While it's a generous act, it's crucial to understand the potential impact on your own credit before signing on the dotted line. Cosigning means more than just vouching for someone's trustworthiness. It's a legal and financial commitment that can have long-lasting effects on your credit health.

We'll enter the world of cosigning and explore how it can affect your credit. We'll cover the basics of cosigning, the risks and responsibilities involved, and when it might make sense to cosign. We'll also compare cosigning to being an authorized user on a credit card and provide tips on protecting yourself as a cosigner. By the end of this article, you'll have a clear understanding of the implications of cosigning and be better equipped to make an informed decision.

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What is cosigning?

Cosigning is the act of adding your name to someone else's loan or credit card application as a secondary borrower. When you cosign, you're essentially promising to repay the debt if the primary borrower fails to do so. This legal commitment makes you equally responsible for the debt in the eyes of the lender.

Why someone might need a cosigner?

There are several reasons why someone might need a cosigner:

1. Limited or no credit history: Young adults, recent graduates, or those who have never borrowed money may have a thin credit file, making it challenging to qualify for a loan or credit card on their own.
2. Low credit scores: Individuals with poor credit scores may need a cosigner to boost their creditworthiness and increase their chances of approval.
3. Insufficient income: Lenders may require a cosigner if the primary borrower's income is too low to qualify for the desired loan amount.

A brief overview of how cosigning can impact your credit

Cosigning can have both positive and negative effects on your credit. On the one hand, if the primary borrower makes all their payments on time, it can help improve your credit by adding a positive account to your credit report. However, if they miss payments, default on the loan, or have the account sent to collections, it can severely damage your credit score. We'll explore these impacts in more detail throughout the article.

How Cosigning Affects Your Credit?

When you cosign a loan or credit card, the account appears on your credit report as if it were your own. This means that the cosigned account can impact your credit in several ways, both positively and negatively.

Cosigned accounts appear on your credit report

1. The debt is listed as your own: When you cosign, the lender reports the account to the credit bureaus under your name, just as they do for the primary borrower. This means that the cosigned debt becomes part of your credit history.
2. Credit utilization ratio increases: Your credit utilization ratio, which is the amount of credit you're using compared to your credit limits, is a significant factor in your credit score. When you cosign, the new debt is added to your total debt balance, potentially increasing your credit utilization ratio and lowering your credit score.

Positive impacts of cosigning

1. On-time payments can boost your credit score: If the primary borrower makes all their payments on time, these positive payment records will be added to your credit history. Consistently on-time payments are one of the most important factors in maintaining a good credit score.
2. Diversifies your credit mix: Having a diverse mix of credit types (e.g., revolving credit like credit cards and installment loans like auto loans or mortgages) can positively impact your credit score. If you cosign for a type of credit you don't already have, it could help improve your credit mix and give your score a slight boost.

Negative impacts of cosigning

1. Late payments, defaults, and collections severely damage your credit: As a cosigner, you're equally responsible for the debt. If the primary borrower makes late payments, defaults on the loan, or has the account sent to collections, these negative items will appear on your credit report and can significantly lower your credit score. Late payments can remain on your credit report for up to seven years, while defaults and collections can stay for up to seven years from the date of the first missed payment.
2. Increases your debt-to-income ratio: Your debt-to-income ratio (DTI) is the amount of monthly debt payments you have compared to your monthly income. While DTI isn't a factor in your credit score, it's an important consideration for lenders when you apply for credit. As a cosigner, the monthly payments on the cosigned debt are included in your DTI, which could make it harder for you to qualify for new credit.
3. Lowers your average age of accounts if it's a new credit line: The length of your credit history and the average age of your accounts are factors in your credit score. When you cosign for a new account, it lowers the average age of your accounts, which could slightly decrease your credit score in the short term.

It's important to note that the impact of cosigning on your credit depends on how the primary borrower manages the account. If they use credit responsibly and make all their payments on time, cosigning could help your credit. However, if they struggle to manage the debt, it could significantly damage your credit health. Strategies to Elevate Your Credit Score By Over 100 Points can help you understand how to build and maintain a strong credit profile.

Risks and Responsibilities of Cosigning

Before cosigning a loan or credit card, it's essential to understand the risks and responsibilities you're taking on. Cosigning is more than just lending your good credit to help someone qualify for financing – it's a serious financial commitment that can have long-term consequences.

You are equally liable for the debt

1. Lenders can require you to pay if the primary borrower defaults: When you cosign, you're not just a backup plan – you're a co-borrower in the eyes of the lender. If the primary borrower fails to make payments, the lender has the right to demand payment from you. They can pursue legal action against you, garnish your wages, or seize your assets to satisfy the debt.
2. You may be responsible for late fees and collection costs: In addition to the outstanding principal and interest, you may also be liable for any late fees, penalties, or collection costs incurred if the primary borrower fails to make payments on time.

Damaged credit can impede your own financing

1. Harder to secure loans or credit cards: If the cosigned account is not managed responsibly and results in late payments, high balances, or defaults, it can significantly lower your credit score. A damaged credit score can make it more challenging for you to secure your own loans, credit cards, or even apartment rentals in the future.
2. May face higher interest rates: Even if you can qualify for new credit with a damaged score, you may face higher interest rates and less favorable terms. This can make borrowing more expensive and add to your financial burden.

Difficulty of being removed as a cosigner later

1. Cosigner release clauses are rare: Some lenders may offer cosigner release programs, which allow you to be removed from the account after the primary borrower makes a certain number of on-time payments. However, these programs are not common and often have strict requirements.
2. Refinancing or closing the account may be the only option: In most cases, the only way to be released from your cosigner obligations is for the primary borrower to refinance the debt in their own name or pay off and close the account. This can be difficult if the primary borrower's credit hasn't improved significantly since the original application.

Potential strain on your relationship with the borrower

1. Financial stress can lead to conflicts: Money issues can put a significant strain on even the strongest relationships. If the primary borrower struggles to make payments or defaults on the loan, it can lead to tension, resentment, and conflict between you and the borrower.
2. You may feel the need to monitor their financial habits: As a cosigner, you have a vested interest in ensuring the primary borrower manages the account responsibly. This may lead you to feel the need to monitor their financial habits, which can be awkward and uncomfortable for both parties.

Understanding the risks and responsibilities of cosigning is crucial in making an informed decision. It's important to consider the potential consequences carefully and have open, honest conversations with the primary borrower about your expectations and concerns before agreeing to cosign.

When Cosigning Might Make Sense

While cosigning comes with significant risks, there are some situations where it might be appropriate. If you have a strong, trusting relationship with the primary borrower and are financially stable yourself, cosigning could help them achieve their goals while building credit.

Helping a responsible borrower build credit

1. Young adults with limited credit history: For young adults just starting out, such as college students or recent graduates, cosigning can help them establish a credit history. If they use the credit responsibly and make on-time payments, it can set them up for future financial success.
2. Recent graduates or those entering the workforce: Even after college, many young adults may not have a long enough credit history to qualify for favorable rates on their own. Cosigning can help bridge the gap as they establish their careers and build credit in their own names.

Temporary measure for a borrower in unique circumstances

1. Job loss or medical emergency: If someone you trust is going through a temporary financial setback, such as a job loss or medical emergency, cosigning a loan or credit card can help them get back on their feet. Just be sure to have a clear plan in place for when and how they'll resume making payments.
2. Unexpected financial setbacks: Life can be unpredictable, and even responsible borrowers may face unexpected financial challenges. Cosigning can provide a temporary safety net to help them overcome short-term hurdles.

You can afford to take on the payments if needed

1. Have a stable income and emergency fund: Before cosigning, it's crucial to ensure you have a stable income and a solid emergency fund. If the primary borrower can't make payments, you'll need to be able to cover them without jeopardizing your own financial stability.
2. Willing to accept the risk: Cosigning is a significant financial risk, and it's essential to be willing and able to accept the potential consequences. If you have any doubts about the primary borrower's ability to repay the debt or your own financial capacity to cover payments if needed, it's best to avoid cosigning.

If you do decide to cosign, setting clear expectations and maintaining open communication with the primary borrower is essential. Discuss the repayment plan, any potential obstacles, and how you'll handle challenges if they arise. It's also a good idea to keep an eye on the account and your credit reports to ensure payments are being made on time and to catch any issues early on.

Remember, cosigning is not a decision to be taken lightly. It's a significant financial commitment that can have long-lasting impacts on your credit and your relationships. Be sure to carefully consider all factors and potential outcomes before agreeing to cosign.

Cosigner vs. Authorized User

When considering ways to help someone build credit, you may also come across the option of becoming an authorized user on their credit card account. While both cosigning and being an authorized user involve linking your credit to someone else's, there are some key differences to understand.

Access to funds

1. Authorized users can make purchases with the credit card: Authorized users receive a credit card linked to the primary cardholder's account and can make purchases up to the credit limit.
2. Cosigners have no access to the borrowed money: As a cosigner, you don't have any right to the funds from the loan or credit card. You're simply lending your credit to help the primary borrower qualify.

Impact on credit scores

1. Both can affect your credit, but in slightly different ways: Accounts where you're an authorized user or cosigner can appear on your credit report and impact your credit score. However, some credit scoring models may weigh them differently.
2. Authorized user accounts may have less impact on your credit: Some credit scoring models may give less weight to authorized user accounts, as you're not legally responsible for the debt. However, if the primary cardholder makes late payments or carries high balances, it can still negatively impact your score.

Becoming an authorized user can be a good option if you trust the primary cardholder to use credit responsibly and you want to help someone build credit without taking on legal liability. However, it's important to note that not all credit card issuers report authorized user activity to the credit bureaus, so it's essential to check with the issuer first.

On the other hand, cosigning is a more significant commitment that involves taking on full responsibility for the debt. It can be a good way to help someone with limited credit history or lower credit scores qualify for a loan or credit card, but it comes with substantial risks.

Ultimately, the decision between cosigning and becoming an authorized user depends on your relationship with the primary borrower, your financial situation, and your willingness to take on risk. Be sure to carefully consider all factors and potential consequences before making a decision.

How to Protect Yourself as a Cosigner?

If you've weighed the risks and decided to cosign a loan or credit card, there are several steps you can take to protect yourself and your credit.

Carefully assess the borrower's financial situation

1. Review their income, expenses, and debt obligations: Before cosigning, have an honest conversation with the primary borrower about their financial situation. Review their income, monthly expenses, and any existing debt obligations to ensure they can realistically afford the new payments.
2. Discuss their plan for repaying the debt: Ask the primary borrower about their plan for making payments on time and in full. Make sure they have a stable income and a clear understanding of their responsibility to repay the debt.

Ensure you can handle the debt if necessary

1. Consider your own financial stability: Evaluate your own financial situation and make sure you have the means to take over payments if the primary borrower defaults. This may involve reviewing your budget, savings, and emergency fund.
2. Have a contingency plan in place: Consider what steps you'll take if the primary borrower can't make payments. Will you be able to cover the payments yourself, or will you need to explore options like debt consolidation or settlement?

Communicate regularly with the borrower

1. Set expectations and boundaries: Before cosigning, have a clear conversation with the primary borrower about your expectations for managing the account responsibly. Set boundaries around communication, such as requiring them to notify you if they're struggling to make payments.
2. Stay informed about their financial situation: Regularly check in with the primary borrower about their financial situation and their ability to make payments. If they experience any changes in income or expenses, work together to adjust the budget and repayment plan as needed.

Try to include cosigner release clauses

1. Negotiate with the lender: When shopping for loans or credit cards, look for lenders that offer cosigner release programs. These programs allow you to be removed as a cosigner after the primary borrower makes a certain number of on-time payments.
2. Understand the requirements for release: If you find a lender with a cosigner release program, make sure you and the primary borrower understand the requirements for release, such as the number of on-time payments required and any minimum credit score thresholds.

Monitor the account and your credit reports

1. Set up alerts for missed payments: Many lenders offer the option to set up email or text alerts for missed or late payments. Enroll in these alerts so you can stay on top of the account and address any issues quickly.
2. Check your credit regularly for any issues: Make a habit of checking your credit reports regularly at AnnualCreditReport.com. Look for any unexpected changes, such as late payments or high balances, and address them with the primary borrower and the lender as soon as possible. Keep in mind that checking your own credit does not hurt your credit scores.

By taking these proactive steps, you can help mitigate the risks of cosigning and protect your credit health. Remember, cosigning is a significant financial commitment, and it's essential to stay actively involved in managing the account and communicating with the primary borrower throughout the life of the loan.

Alternatives to Cosigning

If you're unsure about cosigning or want to explore other options to help someone build credit, there are a few alternatives to consider.

Helping the borrower improve their credit

1. Reviewing their credit reports for errors: Encourage the borrower to review their credit reports for any errors or inaccuracies that may be negatively impacting their credit scores. If they find errors, they can dispute them with the credit bureaus to have them removed.
2. Assisting with budgeting and debt repayment strategies: Help the borrower create a budget and develop a plan to pay down existing debt. This may involve exploring debt repayment strategies like the debt snowball or debt avalanche methods or considering debt consolidation loans to simplify payments and potentially lower interest rates.

Offering a personal loan

1. Allows you to set your own terms: If you have the financial means, you could consider offering a personal loan to the borrower. This allows you to set your own terms, such as the interest rate, repayment period, and monthly payment amount.
2. Keeps the debt separate from your credit report: With a personal loan, the debt won't appear on your credit report, so it won't impact your credit utilization ratio or credit mix. However, if the borrower defaults on the loan, it could still strain your relationship.

Gifting money instead of cosigning

1. No risk to your credit: If you have the financial means and desire to help, you could consider gifting money to the borrower instead of cosigning. This eliminates the risk to your credit and the potential strain on your relationship if the borrower can't make payments.
2. May have tax implications: Keep in mind that gifting large amounts of money may have tax implications. As of 2021, the annual gift tax exclusion is $15,000 per recipient, meaning you can give up to $15,000 to an individual without triggering gift taxes.

FAQs

Conclusion



Cosigning a loan or credit card can be a generous way to help someone build credit or qualify for financing they wouldn't be able to get on their own. However, it's a significant financial commitment that comes with substantial risks, both to your credit health and your relationships.

Before agreeing to cosign, it's essential to carefully consider the potential consequences and have open, honest conversations with the primary borrower about your expectations and concerns. Make sure you understand your rights and responsibilities as a cosigner and have a plan in place to handle any challenges that may arise.

The decision to cosign is a personal one that depends on your unique financial situation and relationship with the borrower. By thoroughly evaluating the risks and benefits and taking steps to protect yourself, you can make an informed decision that supports your financial well-being and helps your loved one achieve their goals.

If you are struggling with overwhelming debt and want to explore your debt relief options, Pacific Debt Relief offers a free consultation to assess your financial situation. Our debt specialists can provide objective guidance relevant information and support to help find the right debt relief solution.

*Disclaimer: Pacific Debt Relief explicitly states that it is not a credit repair organization, and its program does not aim to improve individuals' credit scores. The information provided here is intended solely for educational purposes, aiding consumers in making informed decisions regarding credit and debt matters. The content does not constitute legal or financial advice. Pacific Debt Relief strongly advises individuals to seek the counsel of qualified professionals before undertaking any legal or financial actions.