Banks and credit card issuers ask for co-signers when they believe an applicant's income or credit scores makes him or her a particularly risky borrower. While co-signing for a credit card may be a nice gesture, it puts you at serious financial risk of ultimately paying for someone else's spending.
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But there are ways you can help someone establish credit history and get access to credit without co-signing for a credit card. Here's why you shouldn't co-sign for a card, and how you can help without putting your financial life at risk.
Why co-signing for a credit card is a bad move
You have to have a really bad credit score or low income not to qualify for a credit card in your own name. When a bank asks an applicant to get a co-signer, what it's really saying is, "We don't want to risk lending you money, even if we can earn 18% or more in interest."
Alternatively, the underlying message is, "We need someone else on the hook to pay us back, because we don't think you can."
Co-signing for a credit card makes you legally responsible for the balance and puts your credit at risk if the account is mismanaged in any way, as it is essentially a joint credit card. The card will appear on your credit report as if it were yours. The history -- good or bad -- will appear on your credit report, and it will stay there for as long as seven years.
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Thus, any late payments or a high balance will have a negative impact on your credit score. A single late payment can send your score dropping by 100 points or more, which can be the difference between "prime" and "subprime." It's a very big deal.
But most importantly, as a co-signer, you're on the hook if the main accountholder cannot pay his or her balances back. This problem can be compounded by the fact that co-signing for a credit card for someone else may enable that person to get a higher credit limit than he or she might qualify for without help.
You can only imagine the problems that can happen when someone who can't qualify for a $500 credit limit is given access to a credit card with a $10,000 credit limit because you co-signed for that person. In effect, by co-signing for a credit card, you may be enabling someone to borrow more than he or she could ever responsibly borrow without your help.
Lending a helping hand without the risk of co-signing
You don't have to turn someone down if you're asked to become a co-signer for a credit card. You can help the person get access to credit by helping with opening a secured credit card in his or her own name.
A secured card isn't fancy. Secured cards don't have the best travel rewards or highest credit limits, but they're perfect for someone who wants to establish or rebuild credit history while getting all the benefits that come with an ordinary credit card. Secured credit cards report to the three major credit bureaus, just like any other credit card, making them ideal for people who have bad credit or no credit at all. They also function like any other credit card if you need to rent a car or book a hotel room, two purchases for which credit cards are typically the preferred method of payment.
Best of all, secured credit cards are downright easy to get approved for. That's because secured cards require a deposit that acts as collateral to protect the bank from losses in the event the cardholder cannot repay the balance. This deposit typically takes the form of a $49 to $500 deposit, depending on the applicant's creditworthiness or desired credit limit.
We at Fool.com spent a lot of time looking through the fine print on a lot of secured credit cards, and we ultimately found a couple particularly of attractive cards. The best secured cards we've found offer a credit limit of at least $200 with a deposit ranging from $49 to $200. None of them have annual or monthly fees, which is actually pretty rare in the world of secured credit cards. (If there is one thing to avoid in secured cards, it's monthly or annual fees -- it's not necessary when there are no-annual-fee choices.)
All the benefits without the risk
It's understandable, and even admirable, that people are willing to put their finances on the line to help someone else get access to credit. But it can be a massive financial risk that, in the worst case, could send your credit score plunging from super-prime to subprime and put you on the hook for repaying thousands of dollars of debt because of someone else's spending habits.
If you really want to help out, consider helping someone get a secured card in his or her own name by footing the deposit on the card. In the worst case, you might lose the $49 to $200 you gave the person to open the account. But if the worse comes to worst, you'll be really happy that you didn't co-sign for the card and have no responsibility to repay the person's balances.
Of course, in the best case, helping someone open a secured card enables that person to start building or rebuilding credit and get access to credit in his or her own name, without your financial backing.
In short, co-signing for a credit card exposes you to substantially more financial risk with little to no advantage for you or the applicant. You should help if you can, but not with your signature.
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