Cosigner vs. Authorized User: Which Do You Need?
November 13, 2017
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Although complex, the ins and outs of consumer credit aren’t actually that hard to understand. Unfortunately, the vast amount of lingo and jargon inherent in finance can often make it feel as though you’re trying to put together a puzzle without all the pieces.
Indeed, even beyond the wealth of weird acronyms — like AF (annual fee), APR (annual percentage rate), and CVC (card verification code) — consumer credit has a range of tricky terms that can trip you up. And while you can learn many of these phrases as you go, others can get you into trouble if you don’t know what they mean.
Two good examples of important terms to understand before you dive into a credit contract are two that are often mistaken for each other: cosigner and authorized user. While both represent a certain level of credit co-mingling, that’s where the similarities end, and confusing the two concepts could have unintentional consequences.
Use a Cosigner to Obtain Credit
Each consumer has three credit reports, one each from credit reporting bureaus Equifax, Experian, and TransUnion. Within your individual credit reports is information provided to the bureaus by your previous and current creditors about your payment behavior, including whether you pay your debts as agreed and how much you still owe.
This information in your reports is used by future creditors to determine your potential credit risk. In other words, when you fill out a credit application, that creditor will look at your credit report to see if you pay your debts, using your past behavior as a measure of how likely you are to pay future debts. The information in your credit reports will also be used to calculate your credit scores, which acts as a numerical representation of your reports.
When your credit report contains a lot of negative information, such as missed payments or defaulted accounts — or no information at all — it sends a message to future creditors that you may be a financial risk, meaning they may not get their money back. This can cause you to be charged high interest rates for credit, or to be rejected for new credit altogether. Even lenders who offer bad credit loans may require a cosigner if your score is too low.
Here’s where cosigners come into the picture: a cosigner, also sometimes called a guarantor, is someone who backs up your bid for credit by agreeing to take on your debt should you be unable to do so. Different from a co-applicant, who applies jointly with the primary borrower, cosigners aren’t sharing the debt so much as securing it. To qualify, a cosigner must have a good to excellent credit score and meet any other applicable requirements, including having a minimum annual income.
Because the cosigner provides an extra safety net on the debt — i.e., the creditor knows it will get paid, one way or the other — creditors are more likely to approve an applicant they would otherwise deny due to apparent credit risk. In some cases, you may even receive a reduced interest rate. Indeed, a well-qualified cosigner may pull you right out of the subprime market and into a prime product.
For example, hypothetical househusband, Homer, has a less-than-stellar credit score but needs to apply for an auto loan. The lender doesn’t love Homer’s credit, so he’s asked to find a cosigner. Homer’s wife, Wendy, who has excellent credit, agrees to cosign the loan. With the extra assurance from Wendy (and her responsible credit history) that the loan will be repaid, the lender approves Homer’s application.
Of course, before you rush out to find a cosigner (or to volunteer as one), it’s important to understand the potential risks of being a cosigner. Specifically, a variety of credit risks are associated with cosigning a credit product, especially if the original borrower becomes unable to repay the debt.
Cosigners can experience significant credit damage from delinquent payments should the primary borrower not behave responsibly. And, of course, there’s the ever-present risk that the cosigner will be stuck repaying the debt — or be sued by the creditor if they don’t. Should Homer forget to pay his auto loan, for instance, Wendy’s credit score will likely take a hit. And should Homer stop paying his loan altogether, Wendy will start receiving the bills.
Be an Authorized User to Build Credit
While cosigners can be used to help you obtain credit you might not otherwise qualify for, becoming an authorized user may help you build up your own credit profile without needing to apply for anything yourself. In other words, when you have a low credit score, or have yet to establish one at all, you may need a cosigner; at the same time, if you’re looking to improve your credit, you may want to be an authorized user.
The perks of being an authorized user can be especially useful when just starting on your credit journey. Although you can find many credit cards for no-credit consumers, you can jump-start your credit-building by becoming an authorized user on a well-established credit account.
Primarily a function of revolving credit lines, such as credit cards, authorized users are individuals who are given access to someone else’s credit line. Basically, authorized users can charge purchases to the account as though it were their own, but the primary cardholder will be responsible for repaying the debt.
As an example, consider pretend pre-teen, Penelope, who is going off to summer camp. To prevent Penelope from being penniless in an emergency, her parents make her an authorized user on their credit card. As an authorized user, Penelope will receive a credit card in her own name that is tied to her parents’ credit account. She’ll be able to make purchases with that card anywhere the card is accepted — but mom and dad will still get the bill.
While not responsible for the debt on the account, authorized users will still share some of the credit benefits — and the credit risks. That’s because the credit account for which you are an authorized user will show up on your own credit report in addition to that of the primary cardholder, including the available credit limit and current balance.
Presuming the primary cardholder uses the card responsibly, including maintaining a low balance, having the account on your own credit report can improve your credit score by lowering your utilization rate (worth up to 30% of your FICO score), as well as boosting your credit history length and average age of account (jointly worth 15% of your FICO).
In Penelope’s case, being added to her parents’ card as an authorized user as a young adult means she’ll already have a credit history established when she reaches adulthood and looks to apply for her own credit. Penelope will likely be able to skip many of the less-than-awesome starter cards on the market and head right for a great rewards card or other prime product.
Don’t Let a Few Little Words Hurt Your Credit
With a mind-boggling array of acronyms and jargon, finance can often seem like another language — one impossible to decipher. But in the fight for financial well-being, few tools can be as powerful as simply knowing some key terms. Knowing when and where to use a cosigner or an authorized user, for instance, can not only save you money, but it can save your credit, too.