Co-signing on a loan is a big decision. You are putting your name on something that is not even for yourself. It requires trusting the other party to be as responsible a borrower as you are. This can be disastrous, but sometimes it works out okay.
Regardless, there are implications to your credit profile. Your score could drop, and you could even be left on the hook for the balance. If the other applicant fails to repay and the debt goes to collections, it can really hurt you.
Here’s typically what happens when you co-sign.
Applying Results in a Hard Inquiry
Your credit score has an initial drop from the hard inquiry. This occurs when your credit file gets pulled by the lender to see if your creditworthiness can secure the loan. Typically, your score will drop anywhere from 5 to 25 points after one or more hard inquiries in a specific time frame.
This factor is pretty negligible. Your credit score will lift back up soon after, as long as the loan gets repaid on time. Hard inquiries also only stay on your report for two years and usually impact your credit score for no more than one year.
Your Credit Report Gets a New Account
Assuming that the co-signed loan is approved, there’s now a new account showing on your credit report. How it appears will depend on the specific loan. But, in most cases, it will be an installment debt. This means the borrower must pay a fixed amount across so many intervals of time.
This type of debt will post as the full balance until it’s paid entirely. If it is a one-time need, the goal should be to cover the debt right away. The longer you carry the co-signed loan on your report, the more your score gets calculated with higher debt balances.
As with any debt, the credit reporting agency will notify the bureau every so often. Any payments made on time, or late, will get marked both on the credit report of the co-signer and the borrower. This late payment can impact the credit score of both parties. If it is your first late payment, it could mean 100 points or more lost.
Credit Utilization Ratio — How Does It Change?
Thankfully, co-signing on a loan is not the same as helping someone get a credit card. These installment debts will not play a role in your credit card utilization rate. This means that the second-biggest factor of your credit score will not be harmed. Since 30 percent of your FICO score depends on your credit utilization stance, this is a very good thing to realize.
However, while it doesn’t hurt your utilization rate, it almost does in the perspective of a new lender. Assume you try to qualify for a mortgage: Suddenly, the total debt you carry is higher. If you qualified for a $160,000 home loan prior to co-signing a $15,000 line of credit, now, until it gets paid, you might only be approved for $145,000.
Worst Case Scenario — Credit Score Damage From Co-Signing
By being eligible to co-sign, chances are you take your creditworthiness seriously. The amount you help someone borrow might be negligible versus what you can already borrow yourself. If so, the worst case scenario is that you have to pay the debt yourself — including any interest and penalties.
However, the damage is more crippling if you are unaware of payments in arrears. It is imperative to communicate with the borrower. You need to know if there will be a late payment — so you can prevent it from happening in the first place. As mentioned earlier, your scores could drop 30 to 100 points or more after just one 30-day late entry on your credit report.
Thankfully, there’s a bit of power for the co-signer. You have the right to request monthly statements. This is the simplest way to ensure payments are always made on time, and if a missed payment occurs, you can act on it quickly.
Your credit score will already have enough downward pressure. Just look below at how your co-signed loan can weigh in on some of the main credit rating factors:
- Payment history: 35% of your FICO score depends on your payment history. Any late payments can be severely damaging to your score. A single missed payment could drop your score enough to cost you tens of thousands, especially if you plan to refinance your home soon. Your next loan will get approved with a lesser score, subjecting you to worse interest rates than normal.
- Credit age: 15% of your score is made up of the length of your credit history. This new account is fresh and will influence a lower average age for your open accounts. It will close at some point and no longer be a factor. Regardless, while the account is open, it will only reduce the average credit age of a co-signer.
- New credit: 10% of your score is also fundamentally backed by your new credit. FICO looks at whether you can really afford any new debt you take on. There might be large loans in your name already, and your credit score qualifies you as a co-signer. Yet, you might not be seen as someone able to afford more debt right now. Even though it is not technically yours, it is for this part of your score calculation — which is risky.
Co-signing a loan might not hurt your credit profile as much as you think. It’s more of a concern if you plan to finance a big purchase in the near future. But, absolutely never co-sign unless you trust the other borrower. Also, make sure to have funds available elsewhere in case you suddenly need to pay the loan off to save your credit.