Many people gladly cosign a loan considering it a favor to a friend or relative. It may seem like a good idea at the time. You think you are helping your child buy their first car. Or maybe your sister wants to buy a house. You may think your only responsibility is to sign the paperwork and that’s where it ends.
But beware! Anytime you cosign a loan you are agreeing to be legally responsible for the debt if the person you cosigned for does not pay. By cosigning, you have promised to pay off the entire loan if the borrower does not pay.
Cosigning is required by a lending institution when a person applies for a loan and their credit score and credit history indicate they are a poor loan risk. The lending institution requires a cosigner to guarantee the loan. In other words, the lending institution with millions or billions of dollars in assets will not risk making the loan because they do not think the borrower can pay back the loan.
Proverbs 17:18 says “Senseless is the man who gives his hand in pledge and who becomes surety for his neighbor.” The Bible is telling us that we have no sense if we cosign.
The statistical truth supports the Bible. If you agree to cosign someone else’s loan, the odds are against you. Various sources indicate the borrower defaults on approximately 75% of cosigned loans.
If the borrower makes late payments or does not pay the loan per the agreement, it is reported on YOUR credit report. Your credit report gets a negative hit because someone else did not pay on time. Your credit score will also be affected. So before cosigning a loan you should think about the long term impacts that cosigning could have on your credit score.
Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits. In addition to lending institutions, credit scores are used by other organizations such as mobile phone companies, insurance companies, landlords, government departments and even potential employers.
The credit score is a number assigned to each person that is an indicator of whether they can get credit and the interest rate they will pay. Husbands and wives each have their own credit score even if they have joint accounts.
A credit score is based on five indicators and both positive and negative details are included:
- Payment history (35%) The first thing any lender wants to know is whether you’ve paid past credit accounts on time. This is one of the most important factors in a credit score.
- Amounts owed (30%) Having credit accounts and owing money on them does not necessarily mean you are a high-risk borrower with a low credit score, but it is a factor in calculating the overall score.
- Types of credit in use (10%). The score will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans.
- New credit (10%). Research shows that opening several credit accounts in a short period of time represents a risk—especially for people who don’t have a long credit history. So opening several new accounts in a short period of time will have a negative impact on your score
- Length of credit history (15%). In general, a longer credit history will increase your credit score. However, even people who haven’t been using credit very long may have a high credit score, depending on how the rest of the credit report looks.
There are three main credit reporting agencies: Equifax, Experian and Transunion. The details of how they calculate a credit score may differ, but they all use a numeric score between 500 and 850. The higher the score, the better your rating.
An excellent credit score is over 720. This level ensures the best interest rates and repayment terms for loans. If you want to make major purchases, such as a home mortgage this credit score range is where you want to be.
A good credit score is between 680 and 719. You can still get decent terms from lenders, although not as nice as those offered to borrowers with truly excellent credit scores. If you’re shopping for a first home, a score in this range will get you an acceptable interest rate on your mortgage.
An average credit score is between 620 and 679. This is the absolute minimum credit score you can carry and still get fair mortgage terms. Smaller-ticket items that require financing are doable, however, in this range, you should be taking steps to improve your credit score.
A poor credit score is between 580 and 619. Although you won’t necessarily have any problems getting loans with a credit report score in the high-500 to low-600 range, you’ll get those loans on lenders’ terms. Be ready for higher interest rates, and expect finance charges that will hit you right in the wallet. The good news is that you can increase your credit score by monitoring your credit reports and by being responsible with your finances. Note that this range is also the lowest workable credit score range if you’re shopping for auto financing.
A bad credit score is between 500 and 579. If your credit score falls somewhere in this range, long-term loans, such as a 30-year mortgage, will carry an interest rate at least three percent higher than interest rates awarded to borrowers with good credit. For shorter-term loans, like a 36-month auto loan, expect interest rates almost double those offered to consumers with good credit scores.
A miserable credit score is less than 500. At this point, your credit score is so bad that getting any type of financing is almost impossible. If your credit score is below 500, it’s time for action. Get a copy of your credit report, and make an appointment with a credit counselor.
Americans are entitled to one free credit report within a 12-month period from each of the three credit bureaus. The three credit bureaus run Annualcreditreport.com, where users can get their free credit reports.
It is important for you to review your credit report regularly and report any inaccuracies to the credit bureaus to ensure your credit score reflects your actual credit history. Over 79% of credit reports contained at least one mistake, and 54% of credit reports contained identifying information that was misspelled, outdated, belonged to another person, or was otherwise invalid. At least 30% of credit reports incorrectly showed accounts as open that had previously been closed by the consumer.
If you have a dispute with an item on your credit report, document the error via a letter to the credit reporting agency and send it certified mail. Keep a copy of all correspondence you send and receive. Under the Fair Credit Reporting Act (FCRA), the credit bureaus have 45 days to investigate.
Credit scores are available as an add-on feature of the report for a fee. This fee is usually around $10, as the FTC regulates this charge, and the credit bureaus are not allowed to charge an exorbitant fee for their credit score.
Consider the potential for disaster when cosigning. If the person pays late, misses a payment or defaults on the loan, you get all the problems that come with debt and none of the benefits since you do not have possession of whatever the person bought.
If you are thinking about cosigning, meditate on this verse from Sirach 8:13, “Do not give collateral beyond your means; consider any collateral a debt you must pay.” When you cosign, your signature obligates you to be fully responsible for the loan.