Should you offer credit help to friends or family?
There are risks to co-signing a loan, even when it helps out someone you love.
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Your heart may be in the right place. A friend or family member may ask you to be a co-signer on a car loan or student loan. Or maybe a son or daughter wishes to be added as an authorized user to a credit card account or needs a guarantor to rent an apartment. But before you sign at the X, you should be aware of the risks you’re taking—and be comfortable with what could happen when you share your credit with another person.
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Why someone might need you to share credit
The typical reasons someone may need the credit help of another is because they either lack their own credit history—a young person just starting out or someone who has recently moved to the U.S. from another country—or they have done something to damage their credit and can’t get approved for additional credit or loans on their own.
The person receiving credit help has a better shot of getting approved for a loan or an apartment application or gains access to another person’s credit line on a credit card account. The recipient’s credit score and history is helped when the shared account is paid on time.
Shared credit is still your liability
When you share a credit account with someone, such as co-signing a loan or adding an authorized user to a credit card account, you are ultimately responsible for the debt. If the other party doesn’t or can’t make payments—or goes on a spending spree that neither of you can afford, forcing the account to carry a balance—your own credit will take the hit, too.
Even just getting a new line of shared credit can temporarily lower your score. “The blow-back can be new debt for which you're liable, and (that) can also lower your credit scores, even if it's being paid on time,” says John Ulzheimer, a credit expert and author who formerly worked for FICO, Equifax, and Credit.com.
In other words, you should avoid sharing credit with another if you aren’t ready to take on the responsibility for the full amount of the loan, rent, or credit line. “I'd never in a million years co-sign for a family member or friend, unless I was ready, willing, and able to take on the debt on my own,” Ulzheimer says.
What happens when you co-sign a loan?
Co-signing for a loan is not so different from applying for a loan on your own. “It's very similar, except [the lender goes] through the process for two people, considering two incomes, two sets of credit reports [and two] scores,” Ulzheimer says.That means that even with your good credit score, you jointly could get denied if the other party’s credit is in really rough shape.
What’s more, the bank doesn’t care who makes the payments, so while you and the other party may have an agreement that they will pay, if they don’t or can’t, that payment is on you to keep the loan—and your own credit—in good standing.
What happens when you become a guarantor?
As a guarantor, you agree to pay rent on an apartment if the tenant doesn’t pay. Before leasing the apartment, a landlord will take into account a potential tenant’s credit history and credit score as well as the guarantor’s. So, again, the credit of both parties matter—but your good credit could make the difference in getting the other person with no or poorer credit approved as a renter.
Someone with decent credit that is looking for an apartment in a major city may need a guarantor to qualify for an apartment lease if their income doesn’t meet a minimum threshold. In that case, the landlord will also take into account the income of the guarantor as well. It’s not uncommon for New York City landlords, for example, to require prospective tenant’s have an annual income of 40 times the monthly rent and that guarantors make 80 times—for a tiny studio costing $1,500, that’s either $60,000 for the tenant or $120,000 for the guarantor.
As with bank loans, it doesn’t matter to the landlord who signs the check as long as it clears, so if the tenant can’t make rent, the responsibility falls to the guarantor. “If the guarantor doesn’t step in and pick up the lease payments, the property manager will likely start the eviction process and outsource the collection of the remaining portion of the lease and any fees to a third-party debt collector,” Ulzheimer says. “The debt collector can go after the primary leaseholder and the guarantor. It’s all bad news.”
What happens when you share a credit card?
There are two ways to share a credit card with another person. The first is to add them as an “authorized user” to an existing account. The second is to open a new shared account as a “co-signer.” Both have credit implications for you, though the processes are slightly different.
When you take on an authorized user on your credit card account, typically the authorized user can make purchases on your credit card but you are responsible for paying the bill—and the authorized user doesn't need to formally apply, because their credit isn't a factor here at all. As the account holder, you don’t have to grant the authorized user their own card, so you may share your credit card in name alone. “Adding an immediate family member as an authorized user but not providing them with a card to use, allows them to ‘piggyback’ on your credit,” says Thomas Nitzsche, certified financial educator at Money Management International—this allows your good credit to rub off on theirs, allowing them to establish or improve their own credit for the future.
With co-signed credit card accounts, you both have access to the credit line and you’re both responsible for making payments and you both build (or damage) credit based on how you use the account. To be approved for this new line of credit, you each complete the application and both of your current scores are considered for approval and for the value of the card’s limit. As with co-signed loans, either of you may write the check for the payments, or you may arrange to share the burden by having one person pay their portion to the other.
“Both parties benefit from positive payment history on a co-signed product,” Nitzsche says. “Payment history makes up most of the credit score, and responsible use is also important. Ideally, you don’t want to use more than 50% of a credit card limit at any one time.”
What are some alternatives to sharing credit?
In some cases—such as that too-pricey apartment or new car—the potential renter may have to change course to something they can better afford if a co-signing situation isn’t in the cards. (Roommates and used cars aren’t the worst things!) But there are a few options that can help someone build credit to be approved for their own future apartment, loans, or credit lines.
Get a secured credit card
The first is to get a secured credit card. With a secured card, you pay the credit card company a deposit in exchange for a credit line. For example, a $250 deposit gets you a $250 credit line. You receive a credit card in the mail and are responsible for the payments. For credit-building, keep balances low and pay your bill in full every month.
The best overall secured credit card that we’ve reviewed is the Discover it Secured card. It includes a rewards program where you earn 2% cash back at gas stations and restaurants (on up to $1,000 in combined purchases each quarter) and 1% cash back on all other purchases, as long as you keep your account in good standing.“Secured cards are good options,” Ulzheimer says. “Retail-store cards are easy to get so they're another good option [for building credit].”
Apply for a credit-builder loan
In addition, Nitzsche recommends a credit-builder loan, sometimes called a second-chance loan or credit-builder certificate of deposit. These options are typically offered by smaller financial institutions like local credit unions or community banks.
With a credit-builder loan, you can typically borrow $300 to $1,000 with 6-month to 24-month terms. Once you’re approved for a credit-builder loan, the amount you’re borrowing is placed in an account with the bank or credit union and you won’t have access to this money until the loan is paid off. Therefore, you should only borrow an amount you can easily repay within the term length, plus the interest it will accrue (typically less than 10%). Next, you make monthly payments, and when the term is finished and payments completed, the amount of the loan gets deposited to you in an account you can access to spend as you like. All those monthly payments on a credit-builder loan should get reported to the credit bureaus, which helps to bolster your credit score.
“Just verify that the [lender that issues your secure credit] card or [credit-builder] loan reports to the credit bureaus, or [they] won’t help build credit,” Nitzsche says.
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