Co-signing on a loan or credit card has both potentially positive and negative effects. While a co-signer allows a person to obtain credit at a better interest rate than without a co-signer, it also obligates the co-signer to pay the account in the event of a default by the borrower. Since many applicants who need co-signers are already a high credit risk, co-signers should take care before agreeing to add their names to accounts.
Co-signing on a credit application is a way to vouch for the primary applicant. Co-signing tells the creditor that in the event of a default on payments, the creditor can turn to the co-signer for payment. Although the co-signer is legally obligated to pay the account if the primary borrower does not, the co-signer does not have access to the account. This means co-signers can't use a credit card for purchases if they are only listed as a co-signer, but the account still shows up on their credit reports as financial obligations because they are indeed obligated to pay in the event of a payment problem. Co-signers do a great service to borrowers because they allow applicants to get approved for credit that they can't qualify for on their own. This allows people with no credit or bad credit to borrow money and build up their credit scores by making timely payments.
Lenders are apprehensive about loaning money to applicants who have no credit or bad credit. When a credit-worthy co-signer is on the application, however, the application becomes much more attractive to lenders. Parents sometimes co-sign for their adult children for student loans, mortgages, and other forms of credit. This allows the children to obtain credit at a reasonable interest rate and term while also allowing the parents to do something beneficial for their children. As long as all payments are made in a timely manner, using a co-signer can be an advantageous situation for everyone involved.
Co-signing for someone who does not make payments on time, or who defaults on a credit account entirely, can be a financial disaster for co-signers. Not only does the account become the legal obligation of the co-signer, but the negative payment history may show up on the co-signer's credit report. Even if payments are made as scheduled, the account on the credit report may push a co-signer's credit score down because of the additional financial obligation. Additionally, any time finances are mingled with relationships there is always the potential to create problems. While some friends and relatives can lend and borrow money to each other without any negative repercussions, other relationships cannot withstand something as complicated as co-signing.
A co-signer is obligated to the account until it is paid in full or the primary borrower refinances without the co-signer. There is no time frame where the co-signer's financial obligation falls off the account. Loan applications may also have a longer time frame if a co-signer is involved because additional credit reports must be run and some lenders have additional documentation requirements for applications with co-signers.
Conservative personal financial experts caution against co-signing for any borrower, even if the applicant is a close friend or relative. Other financial experts suggest to people with no credit or bad credit to find a suitable co-signer in order to get approved for credit at a decent interest rate. Potential co-signers should consult with a financial adviser before agreeing to co-sign to find out what the potential financial impact of co-signing will be.