The desire to help a friend or a family member can be strong, especially when it’s your children. Maybe their credit history is down in the dumps, or they’re looking to start building their credit.
“Parents are often willing to cosign for their children because it helps them to build their credit history,” says Vic Patel, founder of Forex Training Group. “However, in doing so, parents put their own credit standing at risk.”
If someone asks you to apply for a credit card with them, don’t agree right away.
3 things to consider before cosigning
There’s nothing inherently wrong with cosigning a credit card. But if you don’t consider the pitfalls, you may end up with credit, financial and relationship problems. This article is written from the point of view of parents who are considering cosigning a child’s credit card, but the principles also apply to friends and other family members.
1. That’s your debt, too
When you cosign, you’re not just vouching for the primary borrower. You’re applying for the credit card as an equal party.
“Although the child may be responsible for the payment, any missed payments will be reflected on the parent’s credit history,” Patel says. “Ultimately, the cosigner is the guarantor of the payments.”
This means you’re responsible for making sure the payments get made on time regardless of whether you’re using the card. If your child misses payments or defaults on the debt, they can contact you to collect the payment.
2. It affects your credit
When you submit the application, the lender will make a hard inquiry on your credit report. This “pull” may ding your credit a bit. That’s not the end, however.
The credit card balance will show up on your credit report as your own. So, if your child carries a high balance, it can hurt your credit because the credit utilization is high. Delinquencies and other negative marks related to the account will also show up on your credit report. And even though you’re not the primary cardholder, you can’t remove them.
3. It can make it harder to borrow for yourself
The more debt you carry, the less likely it is that lenders will be interested in adding more debt to your load. A cosigned credit card account shows up on your credit report as your own. So, lenders will include it in their calculations when you apply for credit.
Lenders will look at your overall debt burden, as well as how much of your income goes to debt payments. If the balance on the card is high, it can increase those metrics and make it harder for you to get approved.
If you choose to cosign
When cosigning, be diligent before and after the card gets approved to make sure the debt incurred doesn’t affect your finances and credit.
1. Vet your child’s financial habits
Before agreeing to cosign, make sure you know how your child manages money. If you have any concerns about his or her ability to make the payments on time or chances of racking up too much debt, nip the problem in the bud by refusing to cosign.
As much as you love your child, your relationship can be strained if he or she doesn’t follow through and you get stuck footing the bill.
2. Have an exit strategy
If you choose to cosign a credit card, double check with the bank beforehand to understand its policy regarding cosigners. For example, can you be taken off the account without having to close it? If so, how long before you can do so?
“With some banks, parents can eventually obtain a release as the cosigner if the child has made a year or more of on-time payments,” Patel says.
If the bank doesn’t have a specific cosigner release policy, speak with your child about the purpose of the credit card. If it’s to build or rebuild credit, decide when he or she can safely close the account and apply for a new one without your help.
3. Keep track of usage
“Parents should have access to the online account so they can monitor card activity and payments along with the child,” says Patel. This process can give you an idea of whether your child has things under control or needs some assistance.
By checking activity regularly, you can notice certain behaviors or problems that can lead to bigger problems down the road. You can also use the process to teach your child how to manage their money well.
Alternatives to cosigning
If you choose not to cosign, let your child know that not all is lost. There are other ways to build or rebuild credit, including:
- Apply for a credit builder loan
- Get added as an authorized user on their credit card instead
- Consider a secured credit card
If your child chooses a credit builder loan, Self Lender is an online company that charges affordable fees for these loans.
If you go with a secured credit card, it’s important to know how it will differ from a regular credit card. Secured cards require that you put up a deposit, usually equal to your credit limit, as collateral. That way, if you default on the debt, the bank can recoup its losses from the deposit.
Otherwise, secured cards function the same as conventional credit cards. In other words, it offers a revolving line of credit you can use over and over again as you pay off what you use.
Whatever you choose, make sure you’re at peace with your choice. Cosigning a credit card isn’t a light decision and can affect you for years to come. Doing it wrong can not only hurt your finances and credit but also your relationship with your child.
Be sure to consider all of the ways cosigning can affect you and your child. Then, be prepared to share your reasons if you choose not to do it. If you decide to do it, on the other hand, make sure you’re involved with the process so you can avoid the major risks.
Also, make sure you know which credit cards offer cosigning as an option – not all of them do. Using SuperMoney’s credit card tool, filter for the type of card your child is looking for and which ones allow cosigning.
Ben Luthi is a personal finance writer and a credit cards expert who loves helping consumers and business owners make better financial decisions. His work has been featured in Time, MarketWatch, Yahoo! Finance, U.S. News & World Report, CNBC, Success Magazine, USA Today, The Huffington Post and many more.