Cosigning for a friend might seem harmless -- until you realize the bank is asking you to take a risk that it isn't willing to take itself. When you cosign a loan, you're taking on the same responsibility for making sure the loan gets repaid as the person actually taking out the loan.
Cosigned Loans Appear on Both Credit Reports
When you cosign for a loan, the loan will appear on your credit report just like it appears on the credit report of the other person. Each month as payments are made (or not made), your credit report is updated to show the new information. Even though you might not know that the person is three months behind on their payments, your credit report informs creditors who check your report that you're three months behind.
In addition to reflecting the payment status of the cosigned loan, your credit report also will show the amount of the loan. Depending on your credit history and what other loans you might be trying to get approved for in the future, this could be a significant blow to your chances of getting a favorable interest rate, or even just getting approved. For example, if you cosign on a $30,000 student loan for a friend, then look for a mortgage, lenders are going to see you potentially owe $30,000 on the cosigned loan, which makes you a much riskier borrower.
Why Your Credit Report Matters
The information in your credit report is used by the credit bureaus to calculate your credit score. The FICO credit scoring formula weights your payment history at 35 percent of your score. Your amounts owed are weighted only slightly less, at 30 percent. When you cosign a loan, both of these factors are affected, usually for the worst. When you go to apply for your own loans, lenders aren't going to give you a break because you're a cosigner.
Cosigning a loan doesn't always hurt your credit. If the borrower pays the loan as agreed every month, all that positive information goes on your credit report, too. In addition, if your own credit history is limited, cosigning could help add to your length of credit history and your variety of debt used, both of which can help your score. However, always consider the risks before cosigning. If you're not prepared to pay the loan in full yourself, don't do it.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."