There is an old saying that goes, “Neither a borrower nor a lender be.” That same adage is particularly applicable when it comes to cosigning a loan for a friend or family member. Despite your good intentions, cosigning a loan has an immediate negative impact on your credit score. Over time, the tiny waves of short-term detriment potentially build into a full-blown tsunami, drowning your credit score for many years to follow.
What is co-signing?
When you co-sign a loan for someone else, you are committing to re-pay the balance in the event they default. Co-signing is a very common practice, applicable to almost any kind of debt from credit cards to cars and homes. You are extending your good credit to someone who has less than stellar credit or no credit at all -a risky proposition.
Initial Impact
The initial impact to your credit score with any credit inquiry –including co-signing a loan—is a resulting drop of several points. Once the loan is approved, the debt is listed on your credit report as if it were your own, also dropping your debt to income ratio; the ratio banks determine to establish your ability to repay a debt based on current income minus obligations. This diminishes your probability of a loan approval for a new car purchase, home purchase, home refinance or opening any new lines of credit.
If the borrower doesn’t pay
In the event that the worst happens and the borrower does not repay his obligation, the falls on your shoulders. You are just as liable and responsible for the debt as the borrower. If a payment is late or missed altogether, your credit score suffers the same substantial drop as the borrower’s does. If the borrower is put into collection, so are you. If the borrower has his car repossessed, you do too –at least on paper.
The long-term impact to your credit history when a borrower misses something as substantial as a mortgage payment for a house you co-signed on, results in your inability to refinance your own home or buy a new home for a least a year. If circumstances continue to travel south in this scenario and the bank forecloses on that mortgage, the foreclosure winds up on your credit also.
The bad news doesn’t end here however. After a borrower and co-signer default, the creditor has the right to file a court judgment against the borrower and co-signer, ordering you to repay the balance. Judgments result in some very dire consequences, with property liens and wage garnishment being the most severe. In fact, if you are a homeowner, a judgment can even escalate from a property lien to a foreclosure filing in some states. If this happens, not only will your credit score will plummet, but you run the risk of losing your home.
Undoubtedly, co-signing a loan has substantial short-term credit consequences, but comes with potential long-term consequences as well. Therefore, you should think carefully before signing your name on the dotted line for any credit obligation.