If you have a steady income and a high credit rating, you may qualify to co-sign a loan for a friend or family member. When you co-sign a loan, you pledge responsibility for repaying the debt in the event that your loved one cannot. The lender reports the loan information on both the primary borrower's credit report and your credit report -- regardless of the loan's status.
Credit Reporting
After you co-sign, the loan appears on your credit report as an installment debt. Unlike revolving debts, such as credit accounts, installment debts possess a "payoff" date at which the debt should be paid in full.
Every month the lender also updates its account tradeline to reflect the payments -- or lack thereof -- made on the account. Should the primary borrower begin missing payments, the loan's status will change from current to delinquent. The lender's tradeline, however, remains on your credit report even if the loan's status changes.
Reasons for Reporting
Some consumers co-sign loans for loved ones without ever realizing that evidence of the loans will appear on their credit reports. The lender reports the loan on the co-signer's credit history because, by signing for the loan, the co-signer assumes the same level of repayment responsibility as the primary borrower.
Because the co-signer clearly cares about her credit rating, the lender knows that, should the primary borrower stop making payments, the co-signer is likely to pay the debt rather than suffer the inevitable credit damage that nonpayment causes.
Positive Effects
A loan in good standing that the primary borrower pays on time each month has a positive effect on both the borrower's credit score and the co-signer's. The co-signer benefits from this arrangement since he receives a positive installment tradeline on his credit report without needing to make the payments. Future lenders see the loan on his credit report and consider it evidence of his responsibility with debt -- even though it is the primary borrower who submits payments to the lender.
Negative Effects
If you co-sign a loan and the primary borrower stops making payments, you are legally responsible for paying the lender. Every month that the lender does not receive payment on the loan, the loan's tradeline reflects a missed payment. Each subsequent missed payment further damages your credit rating. Because you are legally responsible for the debt, the lender can sue you instead of the primary borrower -- resulting in a judgment appearing within your credit file and lowering your score even further.
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