No matter who you are, chances are good someone has asked you for a financial favor at some point. Maybe it was a small loan to cover the costs of moving, an advance on birthday or holiday gift money, or a free place to stay for few days or months. Whatever that favor was, it always feels good to help someone who truly needs it — especially if you can do so without too much risk on your part.
But therein lies the problem. While some financial favors are quick and easy, others can cost you money in unpredictable and often irreversible ways.
Case in point: A family member or friend asks you to co-sign for a credit card, putting not only your money on the line, but your personal credit health as well. What do you do?
Here’s the cold, hard truth: Co-signing for a credit card or loan isn’t fun and games. Whenever your money and credit score are at stake, it’s important to think long and hard before you jump in.
According to the Federal Trade Commission, loan or credit card co-signers should know these key details before they even consider co-signing for a credit card:
- You’re being asked to guarantee a debt. “If the borrower does not pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility,” says the FTC.
- You may be on the hook for the entire debt, plus any additional fees. “You may also have to pay late fees or collection costs, which increase this amount.”
- Depending on your state, you may be liable for any debts accrued, and can be collected from as such. “The creditor can use the same collection methods against you that can be used against the borrower, including suing you or garnishing your wages. If this debt is ever in default, that fact may become a part of your credit record,” the FTC warns.
Should You Co-Sign a Credit Card for a Family Member or Friend?
If you’re starting to think this “favor” sounds awfully risky, you’re absolutely right. By co-signing for a credit card, you aren’t just lending your family member or friend money; you’re loaning them your good name. And if things go wrong, they can easily drag you down with them.
The consequences can be especially dire if you co-sign for someone who doesn’t take their responsibilities seriously. Jeff Rose, Certified Financial Planner from GoodFinancialCents.com and author of the book Soldier of Finance, has seen plenty of trouble come from situations where one party didn’t hold up their end of the bargain.
“If you co-sign for another person who abuses that privilege until it destroys your credit, you could watch your high credit score vanish,” says Rose. “Furthermore, you could be on the hook for thousands of dollars of credit card debt or other consumer debt that could eventually have debt collectors hounding you to repay debts that you may not even know about.”
Remember, when you co-sign for a loan, you’re agreeing to take a risk that the lender wouldn’t take. Whether it’s because your acquaintance has poor credit or a thin credit profile, the bank didn’t feel comfortable extending them a line of credit without a third-party guarantee. When that’s the case, it makes sense to ask the question: “Why?”
“You are not obliged to co-sign for anyone,” says financial planner Kirk Chisholm of InnovativeWealth.com. And if someone you know is insistent, it makes sense to find out why they need a line of credit to begin with. If they simply need money, there are ways to help them without putting your credit at risk. And if they’re trying to build their credit score, there are low-risk ways to do that as well.
- Related: How to Build Credit
Alternatives to Co-Signing for a Credit Card
If you want to help your family member or friend without putting your own head on the chopping block, there are several ways to do so. If your friend needs money, for example, you could always “fill a pre-paid card for the person in their own name,” says Chisholm. That way, they have the convenience of using a card for their purchases, but without all the risk to your credit profile.
This strategy is a good one because “there is a limit to what can be lost,” says Chisholm. “Co-signing on a card could cost you your credit rating,” he says, “which is invaluable.”
And if you’re willing to give out a loan, that’s help enough. Just make sure to get all of the terms in writing, and only loan what you’re willing to lose.
The only downside to offering a loan, whether it’s on or off a prepaid debit card, is that these products do not report to the three credit reporting agencies, and thus won’t help your friend improve his or her own credit over time.
Another option, notes Rose, is for your friend to apply for a secured credit card. “If someone’s credit is absolutely horrible, where they cannot get approved for a card, one option is a secured credit card,” he says.
Secured credit cards — also known as cards for people with bad credit — give users access to a line of credit that they secure by putting down a deposit, usually somewhere between $300 and $500. “If that family member doesn’t have enough cash to open a secured card, then a loan to help them open a card could boost their credit,” says Rose. “But remember, this is a loan and should be treated as such. You are not giving the money.”
While secured credit cards come with fees and their share of rules and special conditions, this strategy might be the best option for anyone hoping to build their credit. Although secured credit cards aren’t the same as traditional, unsecured cards, they do report to the three credit reporting agencies — Equifax, Experian, and TransUnion. Over time, a secured credit card used responsibly can help someone build a credit profile and boost their score over time.
One situation where it can make sense to co-sign for a family member is when you want to use your good credit to help your child build their own, says Rose.
By co-signing for your child or adding them as an authorized user to your own account, you can help them to begin building a credit profile that will benefit them later in life. “In those instances, though, I would closely monitor the account to make sure that bad spending habits don’t become an issue,” says Rose.
In most cases, however, co-signing for a credit card is risky at best and absolutely careless at worst. When there are other ways for the people you love to get access to money or credit, there is simply no reason to put your financial future on the line. Instead of saying “yes” out of sympathy or fear, help your loved one come up with a better way to work through their situation.
If someone asks you to co-sign, the consensus is this: “Just say no.” If you’ve gotten your credit to the point where it could actually help someone else, you shouldn’t risk it. After all, you’ve earned it.
Have you ever co-signed for a credit card or loan? How did it work out?