Danger Zone: Co-Signing Part II

Why does someone ask you to co-sign? They don't qualify, and you do, beware.

Danger #3: credit utilization

What is credit utilization and how can it destroy your credit? Credit utilization is the ratio of your available credit limit on a credit card and the current balance, you want this ratio to be as low as possible to benefit your credit score.

Father co-signs with son on credit card. Son uses entire credit line and pays the minimum payment on-time each month. Is dad effected? Yes. 35% of your FIO credit score is based on paying on-time, 30% is based on debts, which is impacted by credit utilization. Maxing out a credit card can damage the credit as much as being late, credit utilization, or balances, must be monitored and you should know your ratios based on the reported limits on your credit report.

Every month I see several credit scores that would easily be 100 points higher if the credit card balances weren't so high. Pay them down and the score comes back up the next time the creditor reports the lower balance, it snaps back, so that is the bright side.

Danger #4: getting sued

Father co-signs on car and son loses job, doesn't make car payment. Father gets defiant, refuses to pay car payment when lender calls because "it isn't my car." After 90 days car is repossessed, sold at auction for $3,000, loan balance was $15,000, so now $12,000 is still owed. Dad refuses to pay because "it isn't his car." Past due amount is sent to collection. Dad wants to buy a house, but can't, credit score is destroyed by late payments, repossession, past due collection, etc. Dad receives summons to appear in court, doesn't show up because "it isn't his car." Creditor gets default judgment, starts garnishment process. Dad informed by employer that they have received a garnishment for his wages. The next day money disappears from his bank account, garnished by judgment creditor.

Bottom-line: if the person you trusted to pay the debt does not, you need to pay it or life is going to get rough.

Danger #5: bankruptcy

Mom co-signs for son on mortgage, son loses job, mom tries to keep it together, juggles money to pay her mortgage, son's mortgage, and everything else. Mom realizes her efforts are fruitless and decides to file bankruptcy.

Parent co-signs for adult child on credit card, child files for bankruptcy and includes credit card, parent now has a credit card included in bankruptcy potentially reporting on their credit report and most likely owes the debt despite the fact that the co-signer filed for bankruptcy.

Never go into a co-signing situation unless you are fully prepared and able to pay the debt on your own if the other party bails out.

Danger #6: federal government naughty list

Parents co-sign on federally backed Stafford Loan for child going to college. Child attends for a few semesters, spends most of the money during spring break and for cool stuff. Takes a break from college to regroup, student loans eventually become due after 6 months of separation from school. Child not making enough money to pay student loans, puts loans into forbearance for up to three years, meaning no payment due. After three years of avoidance, the loans now need to be paid. Department of Education informs child and parents that the Higher Education Act gives them the ability to bypass the court system and garnish wages directly, and to take any tax refund owed. Oh, and by the way, student loans are not dischargeable in bankruptcy.

Something to know: Stafford Loans (federally backed student loan) are not credit based.

Students can get Stafford Loans based on need with no co-signer since the loan program is not credit driven, a credit report is not even accessed. There is no reason to co-sign on a Stafford Loan, in 2012 for a 4-year undergraduate degree a student can borrow up to $57,500, for graduate school up to $138,000 (includes amount used for undergraduate degree). PLUS Loans for graduate school and private loans are credit driven and some students may not be able to get them on their own without a co-signer.

Let me tell you a secret, add your student onto a credit card that will report as an authorized user on their credit report, ask the creditor if they will report it, if not call one of your other cards until you find a winner. The preferred card has a seven year or more history, low balance, and is paid on-time. Example, 22 year-old added to mom's credit card with a 15 year history, 1% credit utilization ratio, and always paid on-time, the result, an 817 FICO score for 22 year-old, mom and dad no longer need to co-sign on PLUS Loan for graduate school or private loan.

On the Sallie Mae website under FAQ the question "can I get a student loan with no credit"? is answered, "yes, the ones for students do not require a co-signer or credit check." Can a student get a student loan from the government even a day after bankruptcy? Yes, the answer is yes, there is no credit check for a Stafford Loan, but tell your kids about the ramifications of being chased down by Uncle Sam for federal debt if it is not paid back.

Student loans are a topic of their own, so I leave you with this, before you co-sign for anyone, think long and hard about whether you are willing to part with the money, because you may end up paying it yourself.

Have a mortgage or credit question you would like for me to cover on this blog? Shoot me an email so I can address it. If you want to apply for a mortgage for purchase or refinance in Arizona give me a call at 480-203-4641, the application process is easy, and it only takes 10 minutes for me to get the information to get you started on your way to home ownership.

Patrick Ritchie
Mortgage Finance Instructor

Ritchie School of Real Estate Finance

480-203-4641 Cell
Patrick@PatrickRitchie.com

NMLS# 276438 AZ#0913109
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