How Does Cosigning a Loan Affect My Credit Score? Everything You Need To Know

Cosigning a loan for someone can be a huge decision. While you may want to help out a family member or friend by cosigning, it does come with some risks that can negatively impact your credit score. In this detailed guide, I’ll walk you through everything you need to know about how cosigning a loan can affect your credit.

What Does It Mean to Cosign a Loan?

When you cosign a loan, you are legally obligated to repay the loan if the primary borrower defaults or can’t make the payments. Essentially, you are a guarantor on the loan and share equal responsibility with the primary borrower

Cosigning is often required when the primary applicant has poor credit or lacks the income to qualify for a loan on their own. By cosigning, you are leveraging your good credit and income to help the primary borrower get approved and often get a lower interest rate.

Common types of loans that people cosign include

• Auto loans
• Mortgages
• Student loans
• Personal loans
• Credit cards

While cosigning may help out the primary borrower, it does come with risks that can negatively or positively affect your credit. Let’s take a look at how.

How Cosigning Can Hurt Your Credit Score

Here are some of the main ways that cosigning a loan can damage your credit score:

Late or Missed Payments

If the primary borrower misses or makes late payments, it will show up on your credit report as well since you are legally responsible for the debt. Late payments can cause your credit score to plummet by up to 110 points.

Too many late payments in a short period of time can be devastating to your credit scores.

Increased Debt-to-Income Ratio

Lenders look at your debt-to-income ratio (DTI) when deciding whether to approve you for credit. Your DTI compares how much debt you have compared to your income.

When you cosign a loan, the entire loan amount will be counted as part of your total debt when lenders calculate your DTI for future loans. A high DTI can make it harder to get approved for financing.

Account Goes to Collections

If the primary borrower stops making payments altogether and the loan goes into default, it may get sent to collections. This can crush your credit score by up to 200 points.

Even if you weren’t aware the loan was in default, a collection on your credit report will significantly hurt your score.

Potential Credit Inquiries

Applying for a loan triggers a hard inquiry on your credit report, which causes a small dip in your credit score. Too many inquiries in a short period can be harmful.

Repo or Foreclosure

If the cosigned loan is for a mortgage or auto loan, a repo or foreclosure can devastate your credit scores by over 100 points. This is true even if you weren’t actually using the vehicle or home yourself.

As you can see, the risks of cosigning a loan far outweigh any potential rewards to your credit. Now let’s look at the limited scenarios where cosigning may help.

How Cosigning Can Help Your Credit Score

The cases where cosigning improves your credit are limited, but can include:

On-Time Payments

If the primary borrower makes all payments on time, it will be reflected on your credit report as well. On-time payments are the biggest factor in calculating credit scores, so this can give your score a nice boost over time.

Credit Mix

Credit scoring models like to see that you can manage different types of credit responsibly. If you cosign an auto or mortgage loan for example, it may improve your credit mix and diversity of credit. However, this is a minor factor.

Account Paid Off

Closing out a loan that you cosigned for positively can show lenders you are capable of managing credit. Again, this scenario depends on the primary borrower paying off the loan on time as agreed.

While these limited scenarios can benefit your scores, the risks of damage to your credit are much more likely. Now let’s go over some tips if you do decide to cosign a loan.

Tips if You Choose to Cosign a Loan

Before cosigning, follow these tips to protect your credit as much as possible:

• Check your credit reports and scores first so you know where you stand. Make sure your score is in good shape before taking on additional debt.

• Review the loan terms carefully and understand the monthly payments, interest rate, fees, and length of the loan.

• Have a frank discussion with the primary borrower about repayment expectations and create a plan if they can’t make payments.

• See if you can be removed from the loan later once the primary borrower has established a good payment record over time.

• Consider requiring the primary borrower to make you an authorized user on one of their credit cards so you can monitor repayment.

• If you do cosign, monitor the account closely each month to ensure on-time payments. Check your credit reports regularly too.

• Make sure you can afford to take over the monthly payments if needed without damaging your own finances.

While cosigning a loan can put your credit scores at risk, being smart about it can help minimize damage. The most important thing is making sure the primary borrower has a solid plan to repay the debt on time each month. Otherwise, you may want to avoid cosigning altogether.

Alternatives to Cosigning That Protect Your Credit

Here are a few alternatives to consider that don’t require you to put your credit on the line:

• Refer the borrower to a credit-builder loan program to help establish their credit first before applying for a larger loan.

• Lend money directly to the borrower if you want to help, but avoid legally tying yourself to the debt obligation.

• Suggest the borrower look into secured loan options like a secured credit card that require a deposit up front.

• Recommend the borrower boost income with a side gig to improve their debt-to-income ratio.

• Help the borrower improve their credit by adding them as an authorized user on your credit card so they can piggyback on your on-time payments.

• Gift the borrower a small amount for a down payment instead of cosigning the entire loan amount.

While you may not be able to provide as much help with these alternatives, they allow you to protect your own credit standing.

The Bottom Line

As you can see, cosigning a loan is a major decision that can heavily influence your credit score and financial options down the road. While the primary motive may be helping someone out, make sure to look at the pros and cons carefully first and have a solid repayment plan with the borrower. In many cases, there are safer alternatives to cosigning that don’t jeopardize your creditworthiness.

With some careful planning and open communication up front, cosigning may be able to work out fine. But it’s always smart to consult your own financial situation before putting your credit on the line. Know the risks and make sure you can afford take over payments if required. An informed decision today can prevent credit damage tomorrow.