Lending a helping hand to loved ones is a balancing act. If you give too little, you risk damaging the relationships that are most important to you. If you give too much, you could end up incapable of providing for your own needs.
But in some cases, it's not entirely clear how much you're giving. When you co-sign on a loan, it's easy to assume you won't be affected as the cosigner unless the borrower defaults. The reality is that co-signing always carries consequences - namely to your credit. So, does co-signing affect credit score?
Here’s a rundown of how co-signing affects your credit score, and what to do if you’ve already c-osigned a loan.
Co-signing on a loan amounts to accepting full legal and financial responsibility for the borrower’s debt if they default. In rare circumstances, that debt can even be transferred if the primary borrower dies. A borrower typically wants a co-signer when the borrower is unable to qualify for the loan on his or her own, or because co-signing will help the borrower get a better interest rate.
Co-signing is common between parents and children, especially for private student loans and apartment leases. In 2011, more than 90% of private student loans were co-signed, according to the Consumer Finance Protection Bureau (CFPB).
When you co-sign, the loan might show up on your credit report and be reported to all three credit bureaus. If the borrower defaults on the loan, the lender will ask you to take over the remaining debt payments. If you can’t or won’t pay, your credit score will drop along with the original borrower's. Sometimes you can negotiate with the lender for a flat rate or set up a payment plan in exchange for making debt payments.
Even if the borrower makes all their payments on time and remains in good standing with their financial institution, co-signing could affect your ability to be approved for credit. For example, if you are a co-signer on a mortgage, your own ability to apply for a mortgage loan could be hampered. The lender will include that debt when they calculate the debt-to-income ratio, even if you’ve never had to make a payment.
The general rule is to never co-sign on anything you can't afford by yourself. Even if you're completely confident in your friend or family member, the risk of co-signing for a loan you can’t afford is too great. Whether it's for an FHA loan, mortgage loan, car loan, personal loan, student loan, etc., any kind of late payment can have a significant impact on your credit rating as a co-signer.
If you're already a co-signer on a loan, there are two ways to free yourself. First, you can ask the original borrower to refinance the loan under their own name. This probably won’t be possible unless their income or credit report has improved enough to qualify for a loan by themselves.
For example, a 21 year-old senior in college won’t be approved for refinancing because they’re still not a good candidate for a loan. It’s better to wait a couple years until they have a good credit score and their own income.
You may also be able to get out of co-signing responsibility by signing a release form with the lender. A co-signer release absolves you of any association with the loan without otherwise changing the terms. Not every lender offers this, but it’s worth inquiring. Sallie Mae, for example, allows the primary borrower to release a co-signer from a student loan if certain conditions are met.
Zina Kumok is a Financial Health Counselor and Credit Counselor, certified by the National Association of Certified Credit Counselors, who writes extensively about personal finance. See Zina on Linkedin and Twitter.