When it comes to your finances, your credit score can be a big deal.
A good credit score can mean big savings (or costs) if you take out a loan. Good credit can also mean lower costs when you get car insurance in some states.
If you have good credit, you’ve worked hard to manage your finances and your loans in a way that shows you are responsible. You are proving that you are a solid risk.
But what happens if you slip up? How much could that ruin your score?
According to Equifax, the damage affects different people differently. One late payment will affect a person with a lower score, but it’ll have a much bigger impact on someone with a really high score.
That’s right: if you have great credit now, a mistake could mean a bigger hit to your credit score. Someone with mediocre credit won’t see the same impact as the result of a mistake.
Do you have an excellent credit history and want to keep it that way? Here are some things to avoid if you want to keep that credit score in the good to excellent range:
Missed Payments
The biggest factor in your credit score is your payment history. One missed payment can tank your credit score, if you have excellent credit, by as much as 100 points, according to Equifax.
The longer you wait to pay your bill, the worse the impact. If you are just a couple of days late, you might not see a huge change. However, once you reach that 30-day late mark, it’s a problem.
Do your best to plan your finances so you make your payments on time and in full. Easier said than done, I know, but it’s much easier if you have a budget so get one started.
High Credit Utilization
If you have excellent credit, there’s a good chance you carry small balances on your cards — if you carry them at all. Best results come when you use 30% or less of your available credit each month.
But when you start charging, and that credit utilization number starts to climb, you can see changes to your credit score without realizing it. The closer you are to your limit on the credit cards, the more it impacts your score.
If you end up over the limit on your cards, then the score will suffer. Try to continue keeping carried balances low. Better yet, pay off your cards each month and avoid paying the interest.
Cosigning on a Loan
One day you may want to help your child or sibling by cosigning on a loan. It seems like a good idea to cosign on a loan to give them a boost but think twice before you commit.
About halfway through my freshman year in college, the ancient car my parents sent me with died. I decided then that I wanted to buy my own car to replace it. Only problem? I didn’t have the cash to pay for a $3,500 car, and I didn’t have the credit to get a car loan.
My parents came to my rescue, agreeing to co-sign a loan for me. They helped me open an account at their credit union and then co-signed on a loan with the lowest interest rate possible. I made payments faithfully until that car was totaled in an accident a couple of months before the last payment was due. (The insurance payoff allowed me to finish paying the loan with enough left over to make a 50% down payment on the replacement car, though.)
This arrangement helped me build my credit so that I could get my next car loan on my own merits. And, because I was consistent in my payments, it didn’t harm my parents’ credit or cost them any money. This isn’t always the case, unfortunately. Before you co-sign a loan, consider that, according to CreditCards.com, 40% of co-signers lose money. There could be other ramifications as well.
What Happens When You Co-Sign a Loan?
First of all, it’s important to understand that you accept responsibility for the payments when you co-sign a loan. Basically, you are putting your own money and your own credit on the line. You agree to make payments (or pay off the loan if needed) if the borrower doesn’t. This means that you could lose money if you co-sign a loan for someone else.
Another consequence is that your credit can be impacted. If the borrower misses payments, then that is reflected on your own credit history. Even though you aren’t the borrower, you have accepted responsibility for the loan and that means that your credit is also affected if something goes wrong. If you co-sign a loan, you need to make it clear to the borrower that s/he should let you know if payments can’t be made so that you can step in and save your credit.
Speaking of credit, the loan you co-sign will also impact your available credit. It will look like a loan on your credit report and “count” against you if you apply for other loans. Depending on your situation, you might not be approved for other loans if you have a co-signed loan dragging on your available credit or if it impacts your debt-to-income ratio. Having that payment listed might put you over the top of the acceptable ratio if you plan to apply for a mortgage. Before you co-sign a loan, consider what kind of loans you might want in the future.
Could Your Relationship Be Affected?
Relationships can also be ruined by co-signed loans. Are you resentful if the borrower doesn’t make payments? What happens if you push for repayment? Could the arrangement add tension to the relationship?
Carefully think of the financial and emotional consequences before you co-sign a loan. You might feel like you are helping, but if there isn’t a true need involved, or if you are concerned about the ability to be responsible about it, you might be better off when you avoid co-signing.
Your credit is on the line as soon as you sign on the dotted line because you accepted responsibility for all payments as a cosigner. Plus, it will look like you have that debt – even if you don’t. You may not care too much about it now but that can affect how much you can borrow if you were to, say, apply for a mortgage on a dream home in the future. If the borrower misses a payment, that’s on you as well. You can see your credit score fall.
And if you do cosign, make sure the borrower keeps you up to speed. It may be crappy to make their loan payments, but at least it can save your credit if you do.
David’s Note: In many situations where the original benefactor of the loan starts missing payments, the cosigners will help pay the loan off to avoid taking damage to their score and possibly getting shamed and harassed by the collection agencies. It’s fine when everyone makes their payments of course, but if you cosign and then have to pay off the loan at the end, you are basically out many thousands of dollars without getting any benefits of the original loan. Plus, your relationship with the person you were trying to help has likely soured because of all those confrontations you would have had with the person about the missed payments. Is it worth the risk? Sometimes, it’s yes. Most of the time though, it’s no. I’d rather be cautious here, but only you can decide whether it’s worth it.
Do your best to plan your finances so you remain on top of the situation and avoid credit pitfalls.
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“If you co-sign a loan, you need to make it clear to the borrower that s/he should let you know if payments can’t be made so that you can step in and save your credit.” I feel that’s where the problem lies. What if the borrower himself fails to estimate his repayment capacity and goes on to promise the co-signer that he will make payments consistently? I remember my mom asking her best friend to co-sign a home or personal (I don’t remember exactly what it was) loan but she refused after studying the terms of agreement. However, that never went on to impact their equation. Such decisions should never be guided by emotions and both the parties should understand that. Saying no (if required) becomes easier as such
Good for your mom to say no, since I’m sure it wasn’t an easy thing to do.
Co-signing is basically taking on the debt yourself. Not only are you on the hook for the payments, but it also means your own capacity to borrow money reduces. Saying yes to co-sign is really only for very unique circumstances.
This is good advice. I’ve recently paid down on some credit card debt, my utilization was over 30%, got it way under now and just waiting to see how long before there’s a change in my score. My plan is to keep pay off the cards each month from here on.
A few points on co-signing:
1) You and the other party should have clear expectations on payments going in, and what happens if you have to take over payments if the other person can’t pay. Say you co-sign for a car loan for a family member. If you have to start making the payments, you should have a clear agreement as to what happens to the car. Do you get to take the car away? Does it get sold? If I co-signed a car loan, and I had to pick up the payments, I would want the car sold to pay off the loan AND ensure I recouped any payments made.
2) Carefully evaluate what you are co-signing for. Ensure that the loan is being used for something with some tangible value to cover the cost of the loan. Otherwise there is nothing to secure the debt. If you co-sign for an unsecured loan, you need to be willing to take over all of the monthly payments and be OK with never seeing that money again.
Great point about writing down what happens to the secured asset if you have to take over a co-signed loan. Many people would worry about the payments, but few would think of the asset until they need to jump in to save their credit.
The more you think of ahead of time, the better off you’ll be so do your due diligence!
My grandfather told me never to cosign a loan unless you want to consider it a gift. He made one exception for his brother in law back in World War II who was enrolled in the Army. He knew he was good for it, or just wanted to help him out I don’t know which.
Your father is a good man, and being nice must have helped the brother in law immensely. Co-signing a loan is taking a huge risk, but risks do pay off, as in your grandfather’s case.
Decisions decisions decisions.
I believe a lot of people get a bad credit score because they miss payments.
This would likely be credit card payments most of the time. People should always keep track of their spending to know how much money they generate and how much they spend each day.
By doing this, they would be better able to manage their payments and obtain a better credit score.
Can I say Hell NO to that question. Even if that person is your kid(s), parents, or partner. If that your kid(s), parents, or partner stops paying guess who the lender is going to come after? Or even worse, when that person dies, the debt collector is coming after you to pay their bill(s). So again, do not co-sign for anyone what so ever.
Co-signing is basically saying that you share the payment. There’s really no other way to explain it. If you are prepared to make the payments by yourself, then do it. Otherwise, don’t.
It’s that simple!