Shannon agreed to cosign a loan that ended up defaulting. Her credit score taking a hit. Read along as AFCC®-certified Financial Coach Lauren walks her through what to do next to rebuild her credit.
The question
Dear Consolidated Credit Team,
Shannon P., Timmins, On
Need some guidance. A little while ago I decide to cosign a loan with my long-term boyfriend. He wanted to start a business. I wanted to be supportive so I cosigned for him so he could get a little more financing.
Unfortunately, the business went bust. There was no way we had enough money to pay the money back so we had to a consumer proposal.
Now my credit is shot.
How do I fix this situation? I worked really hard and sacrificed a lot to live within my means my whole life so that I would never be in this situation. Here I am anyway. What do I do?
Thanks,
The answer
I’m sorry that your partner’s business didn’t work out. It can be heartbreaking to witness someone you care for experience failure. To be financially tied to their failure is devastating. Unfortunately cosigning is encouraged by many lenders as a way to avoid the predatory practices of subprime lenders. The full risk associated with this responsibility is often glazed over.
Risks and responsibility
Cosigners take on the legal responsibility of a debt without the same rights or opportunities as the account holder. Cosigning a loan can impact your ability to attain your own credit. Lenders will consider you obligated to the other person’s debt, even if you aren’t currently having to make payments. If the borrower is unable to pay and defaults on the loan, payments will fall to the cosigner of the loan. The result hurts credit scores and impacts expenses.
There is potential to improve the cosigner’s credit rating with on-time payments made by the primary borrower. Usually, to cosign you must already have good credit so the benefit is – dull. The real danger is that when someone is being asked to cosign, they are being told that they are helping.
Innately tricky situation
Due to the high-risk nature of cosigning, borrowers are encouraged to ask someone close to them to help. This puts many friends and family members in scenarios where it is difficult to say no.
Sometimes, despite meticulous planning and dedication to living within your means, things can go wrong. Because money can be a taboo topic to talk about, we ask fewer questions, take less time to make decisions and feel the need to keep mistakes a secret. It is also very easy to assign morality to our ability to manage money. We label ourselves good or bad and when things go wrong, whether within our control or not, it can feel like a crisis of identity.
Shame is rampant surrounding financial errors and especially credit. Credit is a measurable factor that we can use to compare and judge ourselves. In reality, a credit score is simply a measure of creditworthiness and is separate from our actual worthiness. Credit scores change frequently and do not always reflect our efforts to manage our money and debt.
The truth is you are a thoughtful steward of your money.
It is clear why you made the decision to cosign, even with all of the risks. You made the best decision you could with the information you had.
Credit can be repaired. Here’s how…
Recommendations
Filing a consumer proposal was a great decision. The consumer proposal programs exist exactly for situations like this.
There is a lot of advice and competing information about how to rebuild your credit. The following is what I would recommend as a counsellor with a client in your situation.
Rebuilding
There are many approaches you can take to improve your credit and you do not have to wait to be released from your consumer proposal to get started.
As you make a plan it is important to consider what your credit goals are. Why are you working to improve your credit? When are you expecting to make your next loan application? Are you hoping to get a mortgage? Remind yourself that your credit score is not a reflection of you, your worth, or your abilities.
It can feel intimidating, but it is important to get a copy of your credit report. You should not have to pay. Ensure that there are no errors in the report. Begin to rebuild with your slate as clear as possible.
Credit Scores
Credit scores are calculated slightly differently at each of the bureaus in Canada. For the average person, it is most important to have an idea of what makes up a credit score so you can put your focus in the right place.
Credit scores are calculated as a combination of:
- Payment History – Are you paying on time and not missing any payments?
- Credit Utilization – How much of your available balance are you using at any given time?
- Credit History – How long have you managed a credit product?
- Number of Inquiries – How often are you applying for new credit?
- Credit Mix – What kinds of credit do you have?
When recovering from a consumer proposal the factors you have the most control over are payment history, utilization levels and credit mix.
You can (of course) control how many inquiries you make but, at this phase, the only products available will be strategic products. Once your score is high enough to apply for others then it will be important to keep in mind how often you open new credit.
History of course takes time, so do not delay.
Counselling
Sometimes it is beneficial to speak with a financial counsellor to make a plan suited for you. They can also help you process some of the feelings that arise after financial disappointments. In Canada, you can see an Accredited Financial Counsellor® Canada (AFCC®) privately or free through an agency. AFCC®s are fiduciaries which means they act out of obligation for what is best for you and not for themselves.
Products
In order to start making improvements to your credit it can e beneficial to work backwards, starting with your credit mix. You will need to get a credit product in order to build a track record of on-time payments and that you know how to manage your utilization. There are a variety of products, each with its own set of pros and cons. The following are two of the most effective methods for people working to improve or establish their credit.
Secured Credit Card
Revolving credit, such as credit cards and lines of credit, is the most impactful at rebuilding credit ratings. This is because the borrower is able to use, repay and reuse the same available balance. Payments made on time and in full show lenders and credit bureaus that you are actively paying attention to your credit balances.
When you are re-establishing your credit you will have to apply for a secured credit card. A secured credit card is one that requires a deposit. The amount of the deposit determines the available balance. For example, if you make a $200 deposit, your available credit balance will be $200. Most often, they range from $50-$10,000 depending on what card you choose.
Borrowers are still required to make payments and the deposit does not act as a ‘pre-payment’. It’s more a type of insurance in the case that a borrower does not pay their balance.
Typically, after a series of on-time payments and a rising credit score, secured cards can be transferred to a traditional credit card. When this happens the deposit is returned to the borrower.
Strategy:
Once you have a secured credit card, utilization will be very important. Ideal utilization is below 30% of the total available balance at any given time. For example, if you have a secured credit card of $200, it’s best to keep your balance on your card below $60 at all times for the greatest impact. To achieve this, it may mean making more than one payment per month. It could also mean only using that credit card for one or two things and paying it off in full each month so you stay below the 30% threshold.
Things to keep in mind:
- Not all secured cards are the same. Some will have a monthly or annual fee attached and some will not.
- Secured credit cards often have high interest rates so carrying a balance is never beneficial.
- Don’t worry about perks or points. You’re building credit and those points come at a cost.
- Look for a card that will report to both Equifax and TransUnion so your score improves at both credit bureaus.
- Read the fine print and ensure you know exactly what the terms of payment are.
Credit Builder Loans
Credit builder loans are a type of instalment loan, however, no money is ever loaned to you. Instead, you make a series of payments into a savings account over a set term. At the end of the term, fees and interest are deducted from your savings and the remaining balance is returned to you. Typically, the fees and interest end up comparable to what you would pay on a credit card over the same period.
These types of loans have a cost but also have a predictable savings amount that you can build into your budget. This helps build a habit of saving and you can continue to pay yourself once the term is over.
Credit builder loans are available from a variety of lenders and range from 6 months to 60 months.
Things to keep in mind:
- A higher payment will not result in more credit improvement. There is no significant benefit to having a higher payment. Increasing the payment or the length of the term will result in more money saved and more interest paid.
- Some of these loans are quite expensive so be sure to weigh the pros and cons for yourself.
- Ensure you are comfortable with the length and payment. You can usually cancel these types of loans but at a cost.
- Some cheaper and shorter-term plans will not return anything at the end of the term—instead, your payment is a fee only.
- Look for a company that reports positive payments to both credit bureaus.
- Read the fine print and ensure you know exactly what the terms are and ask if you have questions.
What to be wary of
False Promises
Anywhere offering a guarantee of “fixed” credit within a period of time is not to be trusted. Credit repair takes time. Secured credit cards and credit builder loans are “pay to play” items but they are legitimate. There are no shortcuts and these ‘fast-fix’ programs come with big price tags and usually end up with more debt for the consumer. You can improve your credit yourself with time and discipline.
Predatory Products
Stay alert to any sales calls that offer you a personal loan to improve your credit. While these have the potential to improve your score over time they come with hefty interest rates. Often, the rates on these loans compound more often making their effective interest rate just below the criminal maximum of 60% per year.
Pay Day Loans are the worst product and are exempt from criminal maximums. Avoid these at all costs. If you are patient your score will improve and you will regain access to traditional products.
Monitor your Credit Report
Monitor your score but try not to obsess. It is important to periodically check for errors and have them corrected. Scores can change dramatically and sometimes not make sense. This can contribute to overwhelming anxiety as you do not have direct control of this number. Each bureau has its own proprietary calculation that is not disclosed to the public. You may have different scores at each and that is okay. Be patient and your score will grow.
Cosigning the loan has put you in a tough spot, but not an impossible one. There is a way through. Hope this helps and wishing you luck on your credit-rebuilding journey!
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Consolidated Credit’s executive director, Jeff Schwartz will review it and give his response here, along with any additional tips that our credit counsellors have to offer. If you need immediate assistance, please call us and a credit counsellor will get you the help you need.
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