Did You Know the pros and cons of establishing credit as a cosigner?
The Credit Card Accountability, Responsibility and Disclosure Act of 2009 made it illegal for credit card issuers to extend credit to people under 21. There are two exceptions to the rule. The applicant must show (via income statements, asset disclosures, etc.) that he or she has the ability to make the payments, or someone older would have to cosign for the account.
Cosigning is a longstanding method for establishing credit, but is not without a considerable downside. In fact, many would suggest cosigning for a credit obligation of any type is a very bad idea. There are, however, several pros to the strategy that may outbalance the cons for some consumers.
The first pro is that becoming a cosigner for a credit obligation can allow someone without credit to build or rebuild a credit file and credit score. That credit obligation can be a credit card, a car loan, a student loan, or a mortgage. Because both cosigners, or obligors, are liable for the payment and the debt, creditors commonly report payments and other account activities for both parties to the national credit reporting companies.
Once the newly opened account appears on your credit reports, it’s only a matter of time before it has some impact on your credit scores. If the account is managed properly, then there’s no reason why it will not help your scores over time. This leads to pro number two, which is that credit-scoring systems treat activity on cosigned accounts the same as they do accounts that have only one obligor.
The downsides to cosigning, however, cannot be ignored. The first issue with cosigning is that if the other cosigner becomes unable to make payments, you can be held fully liable for the debt. In fact, if you cosign for a credit obligation, you should consider it your debt – even if you’ve arranged for the other signer to make the payments. The lender will take that view if the payments stop for any reason.
Likewise, if payments are missed, the account is maxed out, or the liability is otherwise mismanaged, your credit scores will feel the pain. Remember, the lender is going to report the account activity of all signers to the major credit reporting companies. That works well when the account is managed properly, and stings when it’s not.
Another non-credit scoring related problem with cosigning is how it impacts your debt-to-income ratio, or “DTI.” If you apply for a new loan such as a mortgage, the lender is likely to consider your ability to make the payments on the new loan. Because you are already obligated to the cosigned debt, you may not qualify for a new loan because you may not have the capacity to pay for both. Even if the cosigned account is being paid on time, all the time, by the other cosigner, it will still have a negative impact on your DTI, until there is no balance on the joint liability.
Probably the worst downside to cosigning is what happens if the liability goes into default. The lender is going to take aggressive steps to collect the debt. This will likely include negative credit reporting, possibly outsourcing the collection activities to a third-party debt collector, and maybe even a lawsuit. These concerns make cosigning one of the more complicated strategies for establishing credit.