Co-signing for loans and credit cards can help a friend or family member get financing for a car or college, or even help them build their credit. If you decide to help, know that this action is a major decision. Get the facts about co-signing.
What is a co-signer?
A co-signer is someone who agrees to pay a borrower’s debt if they are unable to pay back the loan themselves. When you agree to co-sign a loan, you’re agreeing to allow your good credit score and credit history to improve the borrower’s odds of getting approved for a loan or credit card.
The downsides of helping
Co-signing for a loan obligates you to the loan as well as the borrower. Late payments by the person for whom you co-sign will appear on your credit report as well as theirs. If they default on the loan, you’re in default. This could hurt your credit score. You could be responsible for making the monthly payments. This impact to your personal finances could cause friction between family members or friends. So before agreeing to help, decide if you’re willing to put your personal relationship at risk.
Adding your name to someone else’s loan impacts your own credit even if the loan is perfectly managed. For starters, co-signing increases your debt-to-income ratio (DTI). This number represents all your monthly debt payments divided by your gross monthly income. For example, if you earn $6,000 a month and have debt payments of $2,000, your DTI is 33 percent, below the recommended 43 percent ceiling. That’s good. A higher DTI could reduce your chances of getting new credit if you need it or lower your credit score.
The benefits of helping
Finances aside, co-signing for someone close to you may be good for personal relationships. For example, you might co-sign a loan to help your child pay for college or buy a used car. You can enjoy great personal satisfaction from enabling a friend or family member to manage credit responsibly while reaching a goal.
When it comes to co-signing, you must use your head as well as your heart. It’s not just your good credit on the line. Weigh the potential impact to your personal relationships before you make the decision to help.
Article provided by Local Government Federal Credit Union.