Parents and family members may think they are simply lending a helping hand by co-signing a car loan or credit card application for a child. But they are, in effect, agreeing to pay back the debt themselves, and they often end up doing so.
Well over a third of co-signers – 38 percent – had to pay some or all of the bill because the main borrower didn’t pay, according to a survey published this week by the card comparison site CreditCards.com. Credit scores dropped for more than a quarter of co-signers because the borrower paid late or missed a payment.
About one in six adults has co-signed a loan or credit card application for someone else. About half of those who co-signed did so on behalf of a child or stepchild. A common situation was someone over age 50 co-signing a child’s car loan.
“It can be a good way, if you trust the person, to give them a leg up,” said Matt Schulz, senior industry analyst for CreditCards.com, noting that his own father co-signed the loan for his first car when he graduated from college.
But co-signers need to be aware of the potential risks. When you co-sign a loan, you are contractually responsible to pay the loan if the borrower doesn’t, said Rod Griffin, director of public education with the credit bureau Experian.
In essence, Griffin said, you’re signing the loan because the lender thinks the borrower doesn’t qualify for some reason.
“You’re vouching for that loan,” he said. “That’s a very high-risk thing to do.”
The survey found that auto loans accounted for half of all co-signings, and student loans accounted for 19 percent.
Many private student lenders require co-signers, since students are usually borrowing the money based on their future earning potential, rather than current income, said Persis Yu, director of the Student Loan Borrower Assistance Project, a program of the National Consumer Law Center.
But, Yu said, “A lot of people don’t realize what they’re getting into.” Parents or grandparents may think that they are providing a sort of character reference for the student, she said, rather than committing themselves to repaying the debt.
When someone asks you to co-sign a loan, consider his or her track record in paying back debt on time, said Dennis Johnson, a certified credit counselor in St. Louis with ClearPoint Credit Counseling Solutions.
“Even if the person has the best intentions to pay it back and keep the loan in good standing,” he said, that person may be seeking a co-signer precisely because of trouble doing so in the past.
Here are some questions and answers about co-signing a loan:
Q: Can co-signing a loan affect my credit rating?
Yes. Even if the borrower repays the loan on time, the loan typically will appear as an obligation on your credit report, Griffin said. That means lenders will consider that liability when you apply for a loan yourself. If the additional loan makes your overall debt appear high compared with your income, Johnson said, you may end up paying a higher interest rate on your own loan.
Q: Can I remove myself as a co-signer?
Once you co-sign a loan or credit card application, Griffin said, it’s difficult to get out of the commitment, especially if there have been any late payments.
“It’s highly unlikely the lender would allow you to change that contract,” Griffin said, since the reason a co-signer is required is to reduce the lender’s risk.
One possible way to extricate yourself from a co-signer obligation on a car loan or mortgage is to have the borrower refinance the loan solely in his or her name, Johnson said.
Credit cards are more difficult, he said, but it’s possible that once the card is at a zero balance, you could ask to be removed from the account. The card company can then decide whether to allow the main cardholder to remain as the sole name on the account, or whether to close the account and have the borrower reapply for a card separately.
Some private student lenders promote the option to have co-signers released from their obligation after the borrower meets criteria like making a year or more of on-time payments. But in practice, it can be difficult to obtain a release on a student loan, according to the Consumer Financial Protection Bureau.
Q: How can I protect myself as a co-signer?
The Federal Trade Commission suggests that you try to negotiate specific terms of your obligation before agreeing to co-sign. For instance, you can ask to limit your liability to the principal on the loan, and exclude any extra costs like late fees or court costs.
If you’re successful, ask the lender to include a statement in the contract. For instance, the Federal Trade Commission suggests this language, “The co-signer will be responsible only for the principal balance on this loan at the time of default.”
After you co-sign the loan, you should stay in touch with the borrower to make sure payments are being made on time, Griffin said. If that’s not possible, you can contact the lender to verify the loan’s status, he said. You can also check your credit report periodically, to see if any late payments have posted. Johnson advises doing so at least every three to six months.