One of the most common credit horror stories we hear is about credit lending. This could include lending someone a credit card or co-signing on a loan.
A Personal Anecdote
Not long ago, we had a young man share his story with us:
“My friend needed a new car, but could not afford it because the interest rate offered was too high. With a high APR, even a reasonably priced car resulted in a monthly payment beyond his budget. I gave him a ride to test drive a car and once again, they offered him a ridiculously high APR due to him not having an established credit history. The car salesman then made a suggestion that I wish he hadn’t.
“Why don’t you have your friend cosign for you?”
I had been paying my car loan for almost three years, with no credit card debt and a strong payment history, so my credit was good. Without really thinking, I agreed to cosign since I didn’t need new credit at the time. Then one day, I received a call that my car payment was 60 days past due, the car was up for repossession, and payment was needed immediately.
After checking that my automatic payments on my car loan had in fact been processed, I realized why they were calling.”
Often people don’t realize that they should NOT have been a co-signer until it’s too late.
“I explained to the bank that it was my friend’s and asked them to remove my name.
My friend had his hours cut at work and was struggling to get by. He stopped making payments and was considering just driving the car until it was repossessed. After many arguments, I convinced him to resume payments and work something out to bring the loan back to current. Even with payments starting up again, my credit had already received a history of late payments. I realized that I made a mistake when I signed the loan.”
In situations where an account has gone past due, nothing can be done to have the co-applicant removed. It is possible to remove a co-applicant on some types of loans, but the account must be current and the bank has to approve the removal. This is difficult, especially if the person who is trying to stay on the loan does not have a good credit history.
It is important to remember that cosigning on any loan represents that you are willing to take full responsibility for the loan getting paid as agreed.
In the event that the account is not paid on time or payments are missed, the creditor has a right to collect money from you, as well as send negative information to the credit reporting agencies. Furthermore, if the account is sent to collections, the collection agency can try to collect from both the primary and the cosigner. This includes anything that the law permits, including legal action and negative reporting to the credit card agencies.
Both applicants are equally responsible for payments getting made on the account.
Often people confuse a co-signer or co-applicant with an authorized user.
Co-signer vs Authorized user
An authorized user on a credit card will have their own physical card and can make charges to the account like the primary user. However, the difference is that they are not responsible for payments. An authorized user cannot have their credit affected in the event that the account goes into default.
Where most people get themselves into trouble is by authorizing someone on their account: this gives an individual all of the spending power without the responsibility of having to make payments. Needless to say, this can lead to problems down the road. With no responsibility, the temptation to overspend can be overwhelming. Also, the primary cardholder may find it hard to motivate the authorized user to be responsible or contribute payments.
By the same token, if payments are made on an account consistently, only a co-applicant will receive the positive payment history, an authorized user would not see the account on their credit score.
When it comes to credit, you must understand what you are agreeing to. Be cautious when allowing someone to borrow a card or when you cosign for someone. Doing a favor for a friend or family member can lead to a stressful situation down the road, in the event they fall into financial hardship and discontinue payments or consistently make them late. It’s also important to realize that the damage to your credit can take years to recover from. The only way to fix a credit report from missed or late payments is time and continued responsible credit use.
Parents cosigning for their children should use caution and realize that they will be responsible for missed payments as well. If the parents can’t make the payments in the event that the children don’t, they should be aware of the risks that they are getting themselves into and perhaps reconsider signing.