Can You Build Credit Through Co-Signing?

Always fully understand all the terms of a loan before signing.

Always fully understand all the terms of a loan before signing.

Nothing ties two people together quite like a cosigned loan. The relationship might not be forever, but it will probably endure until you pay the loan off. Creditors are usually very reluctant to let cosigners out of the deal after they jointly contract for a debt. If you can find someone willing to cosign with you on a loan anyway, it may have some distinct advantages.

How Cosigning Works

When two people cosign on a loan, one is the primary loan holder the other is the cosigner. This language is misleading, however. "Primary" means the borrower's name appears first on the loan. It doesn't mean he's the only one responsible for the debt, nor does it mean that the debt will only appear on his credit report. When someone cosigns for you, he can be either the primary loan holder or the cosigner. In either case, he is telling the lender that if you don't pay, he will. Each month, the account activity will appear both on his credit report and on your own.

Building Your Credit

If you need a cosigner, it's probably because you have bad credit, or no credit at all. Lenders aren't eager to advance money to someone if they're unsure that person will pay it back. If this is the case, they want someone else -- a cosigner with a good credit history -- to take responsibility for repaying the loan if the person with a questionable credit history doesn't make the required payments. If you have no credit, using a cosigner for loan approval establishes an account in your name and as such, you can begin building a credit history. If you have bad credit, using a cosigner to establish a new account will raise your credit score over time, assuming you make the payments on time.

The Downside

A cosigned loan only helps to build or repair your credit history if you make timely payments. It will have an adverse effect if you're chronically late. This will bring your score down -- and it will damage your cosigner's score as well. The value of having a cosigner depends entirely on how you handle the account. Further, whether you are the primary loan holder or the cosigner, the loan affects your debt-to-income ratio, which is the tool that mortgage lenders often use to determine if you qualify for a loan. Having a too high debt-to-income ratio can disqualify you for a future loan.

Another Advantage

If your credit score is low or non-existent, you can typically expect to pay a lot of interest over the life of the loan. However, if your cosigner has a great credit score, this is where the distinction between primary loan holder and cosigner begins to matter. Lenders typically base interest rates on the primary loan holder's credit score, not the cosigner's. Therefore, if your cosigner's name appears first on the account, you'll probably receive a much better rate.

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