If you have excellent credit, someone close to you may ask you to cosign a car loan. Or perhaps you're the person with the less-than-stellar credit and you're looking to a co-signer to help you get better terms on your car loan.
Cosigning a car loan is a serious financial obligation because the co-signer is promising to pay the loan if the borrower does not pay.
Agreeing to co-sign is a good idea if you want to help the primary borrower improve their credit scores and you don't mind making the monthly payments on time if they can't. But if you doubt the borrower's ability and willingness to make the loan payments on time, and you don't want to make them if the borrower defaults, co-signing an auto loan is not a good idea.
Why Does a Borrower Need a Cosigner?
If a close friend or a family member asks you to cosign a car loan, their lender is not willing to make the loan based solely on the primary borrower's credit history or income. Your family member or friend may have a low credit score due to late payments or loan defaults, or a high debt-to-income ratio. They might be making the purchase without a down payment.
Self-employed individuals, part-time workers and individuals with new jobs may need cosigners, especially if they don't have a long history of consistent, stable income. When a lender views a borrower as a credit risk for some reason, the lender wants an additional party to also be responsible for the amount of the car loan.
Risks of Cosigning a Car Loan
When you agree to cosign a car loan, you take on certain risks. You're responsible for repaying the loan, but you don't have an ownership interest in the vehicle. The lender can come after you for the payments that are due even if they don't pursue the primary borrower.
Any collection effort the lender can take against the borrower can also be taken against you, including filing suit on the debt and garnishing your bank account or wages if they get a judgment against you.
Before you promise to back up someone else's auto loan payments, it's wise to read the loan documents carefully and consult an attorney if you have questions. Most importantly, you should be sure you can afford to make the payments if something happens and the borrower fails to pay.
Who Benefits When You Cosign an Auto Loan?
As a loan cosigner, you're helping the lender and borrower. The lender has another person obligated to repay the loan if the borrower defaults, and the borrower gets the auto financing they need to purchase the vehicle they want.
A lender may offer a lower interest rate because you're cosigning the loan, which means the vehicle costs the borrower less money.
By cosigning, you're putting your good credit on the line, which helps the borrower build credit to make future purchases without cosigning help. This may be the most important aspect for you, depending on your relationship to the borrower.
How Cosigning a Car Loan Affects the Cosigner
When you cosign an auto loan, the lender adds the obligation to your credit report. One one hand, if the person you cosign for makes late payments or doesn't pay at all, your good credit score could suffer.
If the borrower defaults, you remain responsible. Being obligated for someone else's car loan may impact your credit history or ability to take out an auto loan until the first loan is paid. If you apply for a credit card, the financial institution might set a lower spending limit because your status as a car loan cosigner increases your credit risk.
On the other hand, if the primary borrower makes all of the auto loan payments on time, the good payment record improves the primary borrower's credit report and also boosts your credit score.
Why You Should Monitor the Car Loan Status
Cosigning a loan is the start of your involvement in the car purchase process, not the end of it. You should monitor the car loan status as each of the monthly payments comes due to ensure your borrower meets the payment obligations.
Keeping in touch regularly with the person for whom you cosigned should be a top priority, to protect your good credit rating. Ask the borrower to let you know if they're having problems that might lead to late payments. If they're struggling with student loan payments or other debts, you might want to help make payments. That way, you avoid late fees that increase the cost of the loan, make the debtor's credit score worse, and harm your good credit.
It's a good idea to order free credit reports every 12 months from AnnualCreditReport.com, the official site for Experian, Trans Union, and Equifax, the three credit reporting agencies. You can order all three at once or separately on different 12-month cycles. These reports don't include a free credit score, so you should monitor it on a regular basis until the loan is paid in full.
How Bankruptcy Affects Cosigners
If your primary borrower files for bankruptcy, you remain liable for the car loan debt. Borrowers must list all cosigners on their bankruptcy petitions, so your name and status become a matter of public record. Even if the car is repossessed or surrendered and the bankruptcy court discharges the debt, the creditor still has the right to pursue you for the balance owed on the cosigned loan. That amount can include late fees, penalties, and repossession costs.
Obtaining a Release After Cosigning a Car Loan
By making a certain number of auto loan payments on time and reducing the debt-to-income ratio, your borrower might get to a point at which you can obtain a release as a cosigner. Your loan agreement may state the conditions that establish the borrower's credit is good enough to stand on its own. If it does not, discuss it with the lender before entering into the agreement and have the terms set out in writing.
Another option is refinancing the car loan when the amount remaining is low enough for the borrower to handle it alone. Either way, obtaining a release frees the cosigner's credit for other purchases.
Whether you cosign a car loan for a family member or close friend is a personal decision. Weigh the benefits and drawbacks, consider the relationship, search your heart, examine your budget, and read the loan documents carefully before saying yes or no.