Most people know what a co-signer is, but most don’t know how much effect it has on the co-signers credit and borrowing power.
A co-signer is a person who puts pen to paper on a loan for another individual, saying “don’t worry I’ll pay if this person doesn’t”. This is most common with family members, but it happens with non-family members as well.
Say you’re doing fine financially and your younger brother is just getting started as an adult and asks you to co-sign for his car loan. His credit isn’t great because he missed some credit card payments, it was just a small credit card and it’s all paid off now. He’s your brother, you know he’ll make his payments so you do it.
There are now two risks that you run that are completely out of your control. The first is the possible negative effect on your credit. This loan is now on your credit report exactly as if it was your loan and any missed payments are going to have a negative effect on your credit score. The scary part about this is that you do not get the statements, they go to your brother. You have no idea if the payments are being made. As I just mentioned, anytime a payment is missed or late you are getting a negative effect on your credit score. If this was to happen enough times, depending on where your credit is to start, it could drive your credit down to point where you aren’t able to borrow money yourself. Now you can’t get a credit card, can’t buy a car, can’t get a mortgage.
The second risk is the effect co-signing has on your borrowing power. This is perhaps the bigger risk, and definitely the risk that gets overlooked most often. Let’s continue to use the same example to set this up and show you the risk here.
Lets say the younger brother’s car payment is $500 per month. Now remember this loan is on your credit report just as if it was yours. You go to buy a home, you will qualify for a certain amount based on how much your income is compared to what your financial obligations are. This $500 a month payment counts 100% against you, knocking your mathematically calculated mortgage amount you qualify for down, by having $500 per month added to your liabilities.
But wait, you tell your Mortgage Broker that you don’t even pay that loan, and that your brother has made every payment on time, there’s no need to worry about that loan. DOES NOT MATTER, it’s on your credit report.
OK, ok, ok, but thankfully your brother is on the loan also, so only half counts against you, correct? WRONG. The worst case scenario is that your brother stops paying altogether and that you are left with the entire payment. That is the scenario that is used.
See the predicament you’ve got yourself into here?
Co-signing for someone can be a great way to help out someone you care about, but it’s important to understand the consequences. Make sure that the individual is going to make the payments to not negatively effect your credit. Most importantly, make sure that you are not going to need the borrowing power that you are lending out. The same goes for when you are asking someone to co-sign for you, make sure to understand what you are asking of them.
That about covers it, thanks for your time, I hope you enjoyed the read.
Centum Mortgage Professional