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Many parents want to help their children start building their credit foundation early, and to do so, they become co-signers or allow their children to become authorized users on their credit card accounts. Both of these options have advantages and disadvantages, but do you know the difference?
Here we will clarify the difference between co-signers and authorized users, and then you will be able to make a better decision on which path to take to try to boost credit scores for all parties involved.
A co-signer is also known as a joint account holder who typically has an established credit history with good-excellent credit score. Their main purpose is to help the primary borrower get approved for a line of credit. Co-signers may be required by lenders if the person applying for a line of credit does not have a good credit score, or if they do not qualify on their own due to limited credit history.
For example, many parents will co-sign on student loans when their teen goes off to college. Parents don’t have to co-sign for their child’s student loans; however, the likelihood of a teen to get approved for a $20,000+ student loan on their own (with limited credit history) is slim to none. Some parents may refuse to co-sign because they do not want their credit to be affected by the choices of their children. A co-signer’s credit score could be negatively affected if the primary borrower mismanages their line of credit.
Let’s cover some of the basics of co-signing:
- Allows the primary borrower to qualify for lines of credit they may otherwise get denied for as a single applicant.
- Co-signers may help the borrower receive better interest rate.
- Co-signing can help the borrower establish credit history.
- The co-signer can instill good money management skills and teach the importance of repaying loans.
- The co-signer can act as an extra set of eyes and monitor the status of the account.
- The account will reflect on the credit report of both parties. This can be good if the account is managed responsibly.
- Legal responsibility for payment of the account falls on the co-signer if the primary cardholder fails to pay.
- Delinquencies and defaults will negatively affect the co-signers credit score.
- Can be difficult to remove a co-signer from the account once an agreement has been signed. The contract would have to be altered to be removed as a responsible party.
- The account will reflect on the credit report of both parties. This can be bad if the account isn’t managed responsibly.
Overall, becoming a co-signer comes with more risks than to the primary account holder. There are few benefits to being the co-signer; however, most of them benefit the primary borrower. Think carefully before agreeing to co-sign on a line of credit.
An authorized user has no repayment liability on an account, and unlike a co-signer, their main purpose is to get help building their credit. So the biggest difference between an authorized user and a co-signer is who benefits from the relationship. Adding your child as an authorized user to one of your accounts to build their credit history is a method that has been utilized for a long time. Many parents feel much more comfortable with this approach, rather than co-signing on loans that make them responsible for unpaid debt.
Primary borrowers typically have an established credit history that may help the authorized user build their credit. Just like with a co-signer, there are advantages and disadvantages to this method, but there is much less risk involved for the authorized user.
- If the primary card holder has good credit, being added as an authorized user can help improve your credit score.
- The primary account holder has full financial responsibility for the account.
- When ready, authorized users can be removed at any time.
- If payments are made on time and balances remain low, the account could boost all credit scores linked to the account. This is not universal across all credit scoring models.
- If the primary account holder has bad credit history, it would reflect poorly on the authorized user's credit report.
- Missed and late payments will have lasting negative effects on the authorized users credit.
- Can take a few months for the account to reflect on the authorized users credit report.
Options for Building Credit
As always, there are other options to help your child establish a solid credit history early on. They can apply for a secured credit card on their own, which will require a down payment in order to open the account. That may not seem like the most ideal situation, but the account will be reported to the major credit bureaus, which is the ultimate goal for consumers with no credit history. Once your child has activity showing on their credit reports, they should actively monitor their credit using a free credit monitoring service.