Co-signing is a dangerous proposition. As much as you believe in your friends and family members and their ability to repay loans, cosigning puts you on the hook if something goes wrong. It can also prevent you from being able to get a loan yourself.
Effects of Cosigning
When you cosign for a loan, you're treated as if you took out the loan yourself. Obviously, if the borrower defaults on the loan, you've got to pay off the balance. Not as obvious is the fact that the loan shows up on your credit report as if it were your own. Since your credit report affects your credit score, cosigning a loan for someone else impacts your credit rating, and your generosity when cosigning a loan could come back to bite you.
Loan Size Matters
Lenders will credit you with owing a large chunk of change depending on what you cosigned. According to the Fair Isaac Corporation, which developed the most widely used credit scoring formula, the amount of debt you owe accounts for 30 percent of your credit score.
If you cosigned a small personal loan for a friend, the loan won't add much to your outstanding debt and will have little impact on your credit score. If, however, you cosigned for a large loan, like a student loan or a mortgage, you're going to have a much harder time getting a loan for yourself. Potential lenders will view you as already carrying a large debt burden.
Late Payments Hurt You
Since the loan you cosign for appears on your credit as your own, late payments made by the primary borrower take a bite out of your credit score. If the primary borrower forgets to make a payment one month, you'll have a missed payment appear on your credit report. The missed payment will appear on your credit even if you didn't know the payment was late.
Lenders are more hesitant to make loans to people with poor payment histories, so someone else's negligence can hurt you in a cosigning situation. The converse is also true, however. If the person you cosign for makes all their payments on time, your credit score benefits. Your payment history accounts for 35 percent of your credit score, so while one late payment won't ruin your score, a string of them will.
Minimizing Your Exposure
To minimize the effects of cosigning a loan on your own credit score, make sure you read and understand the terms of the loan. For example, check to see what, if any, collateral you're using to support the loan. If you're pledging your house or car, other lenders may not let you use the same property as collateral later.
It may be possible to negotiate your liability, agreeing to pay just the principal if the primary borrower defaults. Doing so can prevent you from being stuck with interest, penalties and other fees. You may also ask that the creditor notify you of any late or missed payments in writing so you can step in before small problems become big ones.
