One of the most common credit horror stories we hear is about credit lending. This includes lending someone a credit card or more often, agreeing to co-sign on a loan for someone with a riskier financial history.
A Personal Anecdote
Not long ago, we had a young man share his story with us:
“My friend needed a new car, but could not afford it because the interest rate offered was too high. With a high APR, even a reasonably priced car resulted in a monthly payment beyond his budget. I gave him a ride to test drive a car and once again, they offered him a ridiculously high APR due to him not having an established credit history. The car salesman then made a suggestion that I wish he hadn’t.
“Why don’t you have your friend cosign for you?”
I had been paying my car loan for almost three years, with no credit card debt, and I had a strong payment history, so my credit was pretty good. Without really thinking, I agreed to cosign on my friend’s auto loan since I didn’t need new credit at the time. Plus, I wanted to help out my friend and he seemed really excited and motivated by this new car.
Then one day, I received a call that my car payment was 60 days past due, the car was up for repossession, and payment was needed immediately. After checking that my automatic payments on my car loan had in fact been processed, I realized why they were calling.
The auto loan I had co-signed for my friend was past due. My friend had not been making payments and now the financial burden was falling to me because as a cosigner I essentially promised that if my friend didn’t make the payments, I would.
Risks of Cosigning a Loan
Often people don’t realize that they should NOT have been a co-signer until it’s too late.
Once I got a phone call saying that my car loan was 60 days past due and that my car was going to be repossessed, I tried to explain to the bank that it was actually my friend’s car, his auto loan, and asked them to remove my name from the loan and paperwork.
No such luck. In situations where an account has gone past due, nothing can be done to have the co-applicant removed, even if they never intended on making any payments themselves and were only just co-signing to help their friend or family member get access to credit.
It is possible to remove a co-applicant on some types of loans, but the account must be current and the bank has to approve the removal. This is difficult, especially if the person who is trying to stay on the loan does not have a good credit history.
Frustrated I called my friend looking for an answer. It turned out that my friend had his hours cut at work and was struggling to get by financially. He stopped making payments on the car months ago and planned to keep driving the car until a debt collector came to repossess it.
After many heated arguments, I was able to convince my friend to resume payments on the car. I told him I needed him to work something out to bring the loan back to at least current status because his financial mistakes were starting to affect my finances.
But even with the auto loan payments starting up again, my credit had already received a history of late payments that were damaging not only my credit score but my ability to qualify for better interest rates on mortgages, loans, and credit cards. I realized that I made a mistake when I signed the loan for my friend.
Shared Financial Responsibility
It is important to remember that cosigning on any loan represents that you are willing to take full responsibility for the loan getting paid as agreed. In the event that the account is not paid on time or payments are missed, the creditor has a right to collect money from you, as well as send negative information to the credit reporting agencies.
Furthermore, if the account is sent to collections, the collection agency can try to collect from both the primary and the cosigner. This includes anything that the law permits, including legal action and negative reporting to the credit card agencies.
Both applicants are equally responsible for payments getting made on the account.
So why do people continue to co-sign when there are so many reasons not to? Often people confuse a co-signer or co-applicant with an authorized user.
Co-signer vs Authorized user
An authorized user on a credit card has their own physical card and can charge to the account just as the primary user does. However, the difference is that an authorized user is not responsible for payments. An authorized user cannot have their credit affected in the event that the account goes into default.
Where most people get themselves into trouble is by authorizing someone on their account: this gives an individual all of the spending power without the responsibility of having to make payments. Needless to say, this can lead to problems down the road. With no responsibility, the temptation to overspend can be overwhelming. Also, the primary cardholder may find it hard to motivate the authorized user to be responsible or contribute payments.
By the same token, if payments are made on an account consistently, only a co-applicant will receive the positive payment history, an authorized user would not see the account on their credit score.
When it comes to credit, you must understand what you are agreeing to. Be cautious when allowing someone to borrow a card or when you cosign for someone.
Doing what seems like a favor for a friend or family member could actually be financially enabling them and can lead to a stressful situation down the road, especially if your friend or family member discontinues payments or consistently make them late. They may be experiencing financial hardship, but those missed or late payments are damaging your credit in the interim. Damage to your credit score can sometimes take years to recover from. The only way to fix a credit report from missed or late payments is time and continued responsible credit use.
Parents cosigning for their children should use caution and realize that they will be responsible for missed payments as well. If the parents can’t make the payments in the event that the children don’t, they should be aware of the risks that they are getting themselves into and perhaps reconsider signing.