To Co-sign or Not to Co-sign for Family...That Is the Question
Those of you who recently filed bankruptcy (and those bad credit scores) may be tempted, like I was, to ask a friend, parent or relative to co-sign on a loan with you.
Don't do it.
It weakens your position with lenders. Once a lender sees a co-signer on one of your loans—the lender will question your stability and move into “cover their butt” mode. And the way lenders cover their butts, is by forcing you to get a co-signer on your next loan...and the loan after that...and the loan after that.
Bottom line: When you have an existing co-signed loan—the chance of a lender requiring a co-signer on your next loan increases significantly.
There are right ways to recover from bankruptcy (or just rebuild bad credit) properly and quickly. But having a co-signer only delays your recovery and sets you up for complications along the way.
If you are unable to qualify for the credit you need...take it as a sign that it is not meant to be...until you can qualify on your own.
What if you are asked to become a co-signer?
I have a core belief...and it goes something like this, “Lend people money only if you can afford not to get it back and you won't hold a grudge if you don't—but never ever lend people your credit.”
If you're thinking about co-signing for someone...
Don't do it.
There is too much at stake.
If the borrower defaults on the loan, two things will happen to your credit reports and FICO credit scores:
1. If the loan goes into default, the lender looks to you to make the payment(s)...so have your checkbook ready.
2. Each time the loan becomes 30 days past due, a late payment will appear on your credit report(s) for up to 7 years...and as a result your credit scores will be lower than they could be.
Additionally, when you co-sign...
1. The payment you co-signed for is calculated in your debt-to-income ratio. So going in debt for someone else could actually prevent you from getting the credit you need when you need it. And it could increase the cost of credit since your scores may be lower.
2. When each lender reviews your credit report(s) to consider the loan, they will post a credit inquiry that will lower your credit scores.
3. Your own credit card interest rates could skyrocket due to the added debt. In what is becoming more common practice, credit card issuers are reviewing your credit reports and looking for how much debt you have with other companies. This is called a “universal review” of your credit reports and if the outcome is bad, your interest rates can dramatically increase with little notice (this just happened to one of my employees last week).
4. The added debt could lower your insurance credit scores to the point where it could impact your ability to get or keep homeowner's and auto insurance or cause your premiums to increase.
As you can see, there is very little value in co-signing a loan. But there is a lot of downside risk.
And these days your credit score is about more than just your ability to obtain credit...it's about your insurance rates and almost everything else in your financial life.
Co-signing for family members…
I can remember stories about my family members asking our Uncle David to co-sign. I should know, I was one of them.
What I noticed is that after one family member asked Uncle David to co-sign...all the other family members deemed it their birthright to do the same. Whether it was for a car, motorcycle, camera equipment, or business loans...Uncle David was (and still is) there to the rescue. (Does your family have an Uncle David?)
To a lot of my family, Uncle David turned into Uncle David Bank and Trust, Inc. The sad fact is many family members took advantage of his kindness. Some only paid him back after they passed away. Many times he was left high and dry, making the payments for the borrower.
It's a tough balance to be kind to others, even family members, and remain financially responsible. But one thing I know, I never...never... never...loan someone my credit by co-signing. It's just too risky.
What about co-signing for your children?
If you can easily afford your insurance rates to double, your credit card limits to be reduced, and your interest rates on your revolving credit to increase substantially, then go ahead and do it.
I feel it's better to do other things to help your children establish credit.
When my wife and I have children, our plan is to show our kids how to accomplish their credit goals without a co-signer. Will we help them? Sure we will. But not by co-signing. By the time they need to purchase their first car, their credit scores alone will qualify them.
We plan to teach them about the importance of managing their credit and credit scores so they are able to reach and maintain high credit scores; save for a down payment using money they earn (not borrow); and how to compare and select a lender to work with.
What about having a spouse co-sign on a loan?
Well, that isn't co-signing. That's co-borrowing...a different animal altogether. Co-borrowing is common practice among married people on a loan for a car or mortgage. And there is nothing wrong with co-borrowing. The goal, however, would be not to have everything held together. You need to build individual and joint credit so you can weather a storm (i.e., death, serious illness, etc.) on your own if need be.
I only recommend co-borrowing with a responsible spouse. And if you're not married I would even go so far as to suggest reviewing your partner's FICO credit scores! (Should we call this a FICO Pre-Nup?) Consider me paranoid. A person's credit history tends to leave clues. If the clues unearth a trail of bad credit...don't be naive.
About The Author
Stephen Snyder is the founder of the After Bankruptcy Foundation (www.AfterBankruptcy.org), a non-profit organization that provides free resources for helping people recover from bankruptcy. Stephen also writes a free weekly newsletter on bankruptcy recovery (www.LifeAfterBankruptcy.com).