Helping out a credit-challenged friend or family member by co-signing can cause lasting damage to credit and relationships
Everyone needs a helping hand sometimes, but if a credit-challenged friend or family member asks you to
co-sign a loan or credit card, there’s a fair chance you’re going to get burned.
A new CreditCards.com survey of 2,003 U.S. adults revealed the negative results from co-signed loans gone wrong.
- Lost money: 38 percent of co-signers had to pay some or all of the loan or credit card bill because the primary borrower did not.
- Credit damage: 28 percent experienced a drop in their credit score because the person they co-signed for paid late or not at all.
- Hurt relationships: 26 percent of respondents said the co-signing experience damaged the relationship with the person they co-signed for.
While co-signing can be a way to help a loved one with poor or thin credit, co-signers need to be prepared for all the possible negative outcomes that can result from lending your credit to help another qualify for a loan.
“Once you co-sign, you are legally responsible for the debt,” said Michelle Dosher, consumer engagement program manager for the Credit Union National Association. “It can be hard on you and it can be hard on family and friends if that situation doesn’t work out as it was intended.”
Why co-signing is high-risk
While a co-signed loan or card account may start with good intentions, the more financially secure party has a lot to lose.
If someone with a good credit score co-signs a loan or card account for someone with poor credit, the co-signer vouches for this person. By attaching a person with good credit to a loan or card application, lenders may look more favorably upon the application and approve it, which helps the high-risk borrower, but puts the co-signer on the line for the entire amount borrowed if something goes wrong.
“If you co-sign and the person you are co-signing for missed a payment, that amount of debt and any missed payments can become part of your credit history, lowering your score,” Dosher said.
The credit score will be greater if the loan or card bill goes into default, which can happen without the co-signer even knowing. Unless a co-signer keeps apprised of the co-signed account repayment activity, damage can occur before the co-signer can step in and do anything about it.
“It’s your name on the line,” Dosher added. “You might have excellent credit now and someone else’s default could ruin your credit score and affect what you are able to do on your own in the future, like refinance a home or buy a car.”
Click image to enlarge.
Who’s co-signing and why
Co-signing isn’t very popular. CreditCards.com found only 17 percent of adults reported co-signing on a loan or credit card. Some experts believe it’s because most people are already wary of the dangers of co-signing.
“A lot of people don’t co-sign on loans because it requires a lot of information sharing on the co-signer’s part,” explained Rebecca Schreiber, a certified financial planner and co-founder of Pure Financial Education.
Those who have co-signed a loan or card are likely acting with a loved one’s best interests in mind. “Co-signing is a sign of faith in another person,” Schreiber said. “Sometimes we just see a financial transaction and we forget about the message behind that transaction. But co-signing is making a statement that you believe the other person will behave in a responsible way and you have faith in them.”
According to the CreditCards.com poll, co-signers tend to be:
- Older than 50. Twenty-four percent of 50- to 64-year-olds have co-signed a loan or card for someone else, followed by 22 percent of those older than 65. Only 14 percent of 30- to 49-year-olds have been co-signers.
- Wealthy. Of those who earn more than $75,000 annually, 24 percent have co-signed for someone else, compared to only 11 percent of those who earn less than $30,000.
- Helping a child or stepchild. Nearly half (45 percent) of co-signers have done so on behalf of a child or stepchild. Co-signing for a friend was a distant second at 21 percent.
- Signing for an auto loan. Auto loans accounted for 51 percent of all co-signings, followed by personal loans (24 percent), student loans (19 percent) and credit cards (16 percent).
Auto loans may be the most popular form of co-signed loans because lending requirements can be much more stringent than, say, a store credit card. “With auto loans especially, when somebody doesn’t have a credit history it’s harder for that person to get a loan,” Dosher explained. “The co-signer helps you get that loan in the first place.”
All types of loans and credit cards are much harder to get when you are a young adult with a thin or non-existent credit profile, which can explain why many parents are co-signers. Most loans and cards are co-signed for a child or stepchild.
“If you could help an adult child go from a rental situation into homeownership and they just don’t have the credit score built up yet, [co-signing] can be great way to get them started,” said Karen Lee, an author and financial planner. When it comes to helping out a child or stepchild, 58 percent of 50- to 64-year-old co-signers have done this as well as 53 percent of co-signers older than 65.
Damage runs deep
Of the co-signers polled by CreditCards.com, more than 1 in 4 said their credit score was damaged because the co-signed loan or card was paid late or not at all. The survey found more than 1 in 3 co-signers had to pay for a loan or card they co-signed for.
Karen Lee’s extended family experienced that struggle firsthand. Lee’s 30-year-old sister-in-law wanted to buy a house, even though she did not qualify for a mortgage. To help her, the woman’s father co-signed a mortgage with the understanding that Lee’s sister-in-law would make all the payments – but that didn’t happen.
Someone else’s default could ruin your credit score and affect what you are able to do on your own in the future.
“There actually came a time when she thought she was going to foreclose on the property,” Lee explained. “But, my father-in-law’s name was on that loan, so it would have destroyed his credit right along with hers. In the end, even though he was retired and on a fixed income, he managed to keep those payments going.”
If a co-signer gets stuck with the bill unexpectedly, that can strain relationships. Ashley Smith, a 29-year-old mom of two from Washington, D.C., learned this the hard way after co-signing a cellphone account for a childhood friend.
“I did it because she was a good friend. I thought the relationship we had made it worth it,” Smith said. At first, the arrangement worked fine. Later, Smith’s friend stumbled upon financial hardships, but insisted she could still make payments and Smith believed her – until a debt collector told her otherwise.
“When I called my friend, she said she paid the bill. I asked for proof because the company was telling me otherwise,” Smith said. Shortly thereafter, “She told me she made arrangements with the collection agency, but she never did that, either, so it hit my credit,” Smith said. “Then she stopped responding to my phone calls.”
The relationship between Smith and her childhood friend disintegrated. Smith is in contact with her former friend’s twin sister, but even that relationship has been strained as a result of the co-signing mess.
“It was an awkward situation that she put us in,” Smith said. “Now that she owes me money, she doesn’t call. I don’t see her and we don’t talk.”
Avoid co-signing if …
Despite your altruistic intentions, to prevent lasting credit damage, a drained savings account and/or strained personal relationships, pause before co-signing a loan for a struggling loved one if either (or both) of these two situations apply:
1. The person has a pattern of not meeting financial obligations.
“We all know people who are financial train wrecks,” Lee said. “If one of your financial train-wreck friends comes to you for help, but they’ve \u2018turned over a new leaf,’ I would still avoid that situation.”
Even if you truly want to trust the promises of a loved one, it’s not uncommon for individuals to fall back into old habits or situations. Really evaluate the nature and financial stability of the person you want to help by co-signing.
2. You’re not financially stable.
In addition to evaluating the person you may co-sign for, you need to evaluate your own financial well-being. Do not sign on the dotted line if you are feeling financial strain.
|\u2014 Karen Lee|
Author and certified financial planner
Based on CreditCards.com poll findings, co-signers who make less money are more likely to report negative outcomes of co-signing agreements. For example, 58 percent of those who make less than $30,000 annually said they were stuck with some or all of a loan or card bill after co-signing. The less you have to give, the greater a burden the co-signed loan could become if you had to suddenly foot the bill or settle a debt collection.
“If this person lost their job yesterday and called you up and said he or she can’t make the payment, what would you do?” Schreiber said. “Could you afford this loan if you had to carry it for a period of time?”
Here’s a good rule of thumb: “If you don’t have [the funds] to literally give away right now, don’t do it,” Lee said.
The 2016 CreditCards.com co-signing survey was conducted by Princeton Survey Research Associates International via telephone interviews with a nationally representative sample of 2,003 adults living in the continental United States, including 388 co-signers, from April 14-17 and May 5-8, 2016. Statistical results are weighted to correct known demographic discrepancies. The margin of sampling error for the complete set of weighted data is plus or minus 2.6 percentage points.