Don't Make This Huge Mistake With Your Credit in 2023

What seems like a simple favor could come back to haunt you.

It might seem like a reasonable request at first: A friend or family member tells you they don't have the best credit, and they ask if you'd be willing to cosign for them on something that requires a credit check. That could be a loan, a credit card, or a rental contract, to give a few common examples.

This isn't a decision to take lightly. Cosigning can be one of the biggest credit mistakes, so before you even consider it, you need to know about the potential drawbacks.

How cosigning works

When you cosign on a financial contract, you're agreeing to be responsible if the primary applicant doesn't pay. If you cosign on a loan and the borrower stops paying, you're required to make payments. If you cosign on an apartment lease and the tenant defaults, the landlord can come after you.

The reason somebody would ask you to cosign is because you have better credit than they do. During the application process, the creditor will check both the borrower's credit and the cosigner's credit. If the borrower doesn't have a high credit score and they apply alone, they might be denied or receive unfavorable terms, like a high interest rate. If you have excellent credit, then you could help them get approved.

The dangers of cosigning

Cosigning is a situation where you take on all the risk and get none of the reward. It's the person you're cosigning for who benefits. Here are the risks involved for you:

• You're equally responsible for the financial contract. If the borrower doesn't fulfill their obligations, you're on the hook.
• It could affect your credit score. When you're a cosigner, that contract can be reported on your credit file. If the borrower defaults, it's just as damaging to your credit as if you defaulted.
• It could limit your access to credit. Lenders consider your current debts, including from accounts you're on as a cosigner, when deciding if they'll approve you for loans and credit cards. So, if you're cosigned on a large loan, that could prevent you from getting approved for a new loan or credit card yourself.
• It could affect your relationship with the borrower. Mixing money with friends and family can go very poorly. If you agree to cosign for someone, and anything goes wrong, it could make for an awkward dynamic and potentially ruin your relationship.

There's really only one way that cosigning can go right, and that's if the borrower makes all their payments without issue. On the other hand, there are all kinds of ways it can go wrong.

Maybe your friend isn't good about making their loan payments on time. You start getting letters saying there's a missed payment. That puts you in the awkward position of going into parent-mode with your friend, asking them why they haven't paid on time and if they could please do it soon to get this lender off your back.

Here's another thing to keep in mind: It's not easy to get your name off a contract when you're a cosigner. This usually requires a new contract between the borrower and lender. For example, with a loan, the borrower would likely need to refinance it. Otherwise, you're on that contract for as long as it lasts.

Have a falling out with the borrower because they always pay late? It doesn't matter. Even if you two aren't speaking, you're still the cosigner, and the one responsible for paying if the borrower doesn't.

Should you ever agree to cosign?

Be extremely selective about cosigning on anything. You should only agree if you trust the other person and if you're ready to pay off their debt to protect your credit score.

To be fair, cosigning doesn't always backfire. But you need to consider how well you know this person and if you should even be putting yourself in this situation. You are, after all, putting your credit and financial security on the line. Even if you think you know someone well, you may not know how responsible they are with their finances.

The situation where it makes the most sense to cosign is if you have adult children who are working on their credit for the first time. It can be challenging to build your credit score from scratch. By cosigning on your child's credit card or loan application, you could be a big help for them.

When you've worked hard on your credit, you don't want to lose all your progress because of a mistake. Being a cosigner is one of those decisions that could have severe consequences. In most cases, it's better to err on the side of caution.