Should you co-sign on a credit card?
Co-signing a credit card with someone is a bit like jumping out of a plane with them. If all goes well, you will both get back on your feet with a boost to both of your credit scores.
But it’s also risky: If one person derails the deal by making late payments or accumulating a large balance, it could hurt both people’s finances as well as their relationship.
And it happens more often than you might think – about one in five co-signers experience a drop in their credit rating, and one in five end up paying debt they don’t own, according to a Bankrate survey. This is why personal finance experts generally caution against co-signing if there are other options available.
Here’s what you need to know before agreeing to co-sign someone else’s credit card – and other alternatives that may work better for both parties.
What is a credit card co-signer?
A credit card co-signer is someone who signs a credit card agreement with another person, usually to help the other person qualify for a card they would not otherwise qualify for. All charges on the credit card become the responsibility of the card account holder and the co-signer. Unlike a joint cardholder, a co-signer does not have access to the account or their funds, only the liability for the debt.
If you co-sign for someone and they don’t pay their bills, you will be contractually obligated to pay that debt. Therefore, co-signing is a decision that should not be taken lightly. It can hurt both your finances and your credit score if it doesn’t go as planned.
“There is also a potential risk to your personal relationships,” says Rod Griffin, senior director of public education and advocacy for the Experian credit bureau. “If you cosign for a friend and that friend doesn’t pay that debt, you’re going to lose confidence in them, you’re going to be angry with them, and you might lose that friendship.” If it is a family member, it can be even worse in some ways.
Before co-signing for someone, discuss their budget, how they intend to use the card, and their plan to pay it off on time and in full each month. “It’s very important to have some kind of written agreement, even if it’s your own child,” suggests Beverly Harzog, credit card expert and consumer credit analyst for US News and World Report. .
Why would someone need a co-signer?
Typically, a person may need a co-signer because they may not qualify for a credit card or loan on their own.
If someone is accumulating credit for the first time, or if they’ve had payment issues in the past, they may need a co-signer to qualify for a new card, Griffin says.
Every time someone uses a credit card, they borrow money and pay it back when the bill is due. Banks and credit card companies want to make sure they get paid off, which is why they will look at a borrower’s credit rating – which shows the likelihood that the borrower will pay off their debts – at the time of payment. decide whether or not to approve a credit card. . Having a co-signer with a good credit rating gives the lender more confidence that the debt will be paid off, Griffin explains. This is why it may be easier for a person with bad credit to qualify for a card if they have a co-signer with good credit.
Someone might need a co-signer if:
However, keep in mind that not all credit card issuers allow co-signers, Harzog says. In fact, most of the major emitters don’t.
Does co-signing have an impact on your credit?
Co-signing can have a positive or negative impact on your credit. “When you co-sign for a card or someone co-signs for you, that credit card account will show up in both your credit history and the other person’s credit history,” says Griffin.
This means that if the account holder carries a month-to-month balance, your debt-to-income ratio will increase along with your credit utilization ratio. This could lead to a drop in your credit score and affect your ability to qualify for new credit. If the account holder misses a payment, it will show up on your credit report and affect your score. And if the account holder accumulates a balance that they cannot afford and defaults altogether, “it’s going to hurt your credit score and your bank account because you’re going to have to pay those debts under it.” ‘a contract, “Griffin said.
On the positive side of things, if the account holder maintains a low balance over the credit limit, it could actually lower your credit usage rate and increase your score. Each on-time payment also has the potential to improve the scores of both people involved.
If you co-sign a card, you must let the cardholder know that you expect them to use the card responsibly and ask them to agree in writing to make payments on time and in full. But financial challenges can disrupt even the best-laid plans. That’s why Harzog offers the following advice: “Don’t co-sign on a credit card unless you can afford to pay off a balance, just in case things don’t go well.” ”
Alternatives to co-signing on a credit card
If you want to help a friend or family member build credit, but don’t want to take the risks associated with becoming a co-signer, here are a few other options to consider:
- Adding an authorized user: If you have a good credit score and want to help a loved one, adding them as an authorized user to your credit card account is much easier and safer than co-signing their card. “An authorized user benefits from your credit history, but is not responsible for the debt,” says Griffin. If you add an authorized user, you will still have control of the account, and you can even prevent the authorized user from making charges on the account by not giving them access to a credit card. Just keep making payments on time to this card, and it will positively affect your authorized user’s credit score. However, be aware that not all credit card issuers will report authorized user activity, according to Harzog. Make sure your card offers this benefit before continuing.
- Student cards and secure cards: If someone cannot qualify for a regular credit card, they may have better luck with a student credit card or a secured credit card. Student credit cards are for young people who are building a credit history and generally have more flexible credit standards than traditional cards. Some student credit cards may require proof of enrollment at an educational institution to be eligible. Secured cards require an initial deposit which acts like the card’s line of credit. Since the deposit serves as collateral, reducing the risk of the card issuer, it is generally easier to qualify for traditional cards. These beginner’s credit cards are a great way to get your foot in the door, and making consistent, on-time payments can help someone improve their credit score even further.
- Manufacturer credit: A credit loan from a local bank or credit union is another way for someone to independently build credit, suggests Harzog. Like a secured credit card, these loans require a deposit. The borrower does not get their down payment until they have fully paid off the loan, but their on-time payments will be reported to the three credit bureaus to help them build or improve their credit rating. Credit cards are generally a more efficient way to accumulate credit, says Harzog. But a home equity loan can be a good alternative or supplement to a credit card.
Co-signing a credit card for a friend or family member may seem like an easy way to help them build credit, but the risks to your finances and your relationship with that person are significant. Experts recommend against co-signing a credit card with someone – there are almost always better alternatives available.
If you want to help someone build their credit without risking harm to yours, you can add them as an authorized user to your account without giving them access to a credit card. This will allow them to benefit from your credit history but will not be able to make purchases on your account.
If you do decide to co-sign despite the risks, be sure to sit down with that person and write an agreement that outlines how the card can be used and how and when it will be paid for. If possible, apply for the credit card with them as the joint account holder rather than as a co-signer. This way, you will have access to the account and can track their spending. This will allow you to put things right before the debt balance gets out of hand.
“Sometimes saying no, my friend, is the right answer,” Griffin said. If so, you can let the person know that you are not suspicious of them – you are just taking conventional advice on what is a tough decision. Suggest another way to help, such as offering budgeting tips or debt repayment strategies. And suggest a few alternatives for the person to build their credit score independently. Most likely, your loved one will understand – and refusing to co-sign will put less strain on your relationship than a potential financial fiasco with a co-signed credit card down the road.