Co-Signing for a Car: Everything You Need to Know
Co-signing for a car comes with a few risks. Understanding these risks can help you decide if you should co-sign for a car for a family member or friend. Before agreeing to take on the responsibility that comes with a co-signed auto loan, you’ll want to evaluate the borrower’s financial situation and ability to make payments. Otherwise, you could end up paying off the auto loan without ownership of the vehicle.
What Does Co-Signing a Car Mean?
Co-signing on a car loan means you agree to back the loan. If the initial borrower defaults on the loan, it becomes your responsibility. Someone might ask you to co-sign on a car loan if they’re unable to get an auto loan on their own. Or, they want you to co-sign because if you have a higher credit score than they do, it can earn them a more competitive interest rate.
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Auto lenders typically require a co-signer when the original borrower has bad credit or a high debt-to-income ratio. A co-signer who has a good credit history reduces the risk of lending to the primary borrower. The co-signer is legally responsible for paying the auto loan, meaning the lender might pursue collection efforts to recoup their costs on a defaulted loan.
A co-signer is a borrower who agrees to accept the credit risk that comes with the loan. The co-signer agrees to pay the entire loan amount, even if the primary borrower stops paying. If the co-signer also defaults, it affects their credit score and borrowing abilities.
When you co-sign an auto loan, you share the responsibility without having ownership of the vehicle. This differs from co-borrowing, where both borrowers have equal rights to the vehicle. A co-signer is legally obligated to pay the loan if the initial borrower doesn’t.
Pros of Co-Signing for a Car
Before co-signing a loan, it’s important to consider the pros and cons. Here are a few pros you might enjoy if you co-sign a loan:
Help a Friend or Family Member
When you co-sign a loan, you have the opportunity to help a friend or family member who has poor credit or has recently gone through a difficult financial situation. Depending on the outcome, this could strengthen your relationship with the primary borrower.
Improve Your Own Credit Score
Co-signing a car loan could also potentially improve your own credit score. Timely payments or a paid-off auto loan could boost your credit score from good to excellent. This can help you qualify for a lower interest rate when you apply for your own car loan or other lines of credit.
Teach a Child Good Financial Skills
Getting a new loan without a credit history can be just as difficult as getting a loan with bad credit. Parents sometimes co-sign a car loan for their teenagers to ensure they have a safe and reliable vehicle. Parents can also use this as an opportunity to teach teens good financial skills, such as how to build credit. Also, it might be easier to ensure the primary borrower is making payments when they live in the same household.
Cons of Co-Signing for a Car
Before agreeing to help a friend or family member, it’s important to consider the disadvantages that come with co-signing a car loan:
It Could Negatively Affect Your Credit
Co-signing a loan means the loan might show up on your credit reports. If your friend or family member doesn’t make their monthly payments, it could lower your credit rating. If they frequently make late payments, this might also show up on your credit record.
If the borrower defaults on the loan and the car gets repossessed, it will likely show on your credit report. According to Experian, it can take up to seven years for a repossession to come off your credit report.
It Could Be More Difficult to Qualify for Your Own Auto Loan
Adding a new loan to your credit, even as a co-signer, can affect your own loan eligibility. When you co-sign a loan, you limit your own borrowing power because you add more debt to your debt-to-income ratio (DTI). Auto lenders typically prefer borrowers to have a DTI below 36%. This means co-signing a loan could affect your ability to make future financial decisions, including buying a car or house.
You Could be Financially Responsible for the Car
If the original borrower stops making payments, you might be responsible for the entire loan cost. This includes collection costs, late fees, and missed payments. You might even get stuck paying off the auto loan after selling the vehicle, if the remaining loan amount is more than the car’s worth.
Debt Collectors Might Reach Out to You
If the initial borrower stops making their payments, you might get harassed by debt collectors. A co-signer’s contact information is usually just as readily available as that of the primary borrower. Debt collectors might call you frequently and demand you make any late or missed payments.
Defaulted Loans Could Ruin Your Relationship
It’s also important to consider how your relationship might be affected if the primary borrower defaults on the auto loan. If they stop paying, and it affects your credit, you might be resentful toward them. If you cannot take out your own auto loan or buy a house because of the arrangement, it will likely have a negative impact on your personal relationship.
Should You Co-Sign for a Car?
Co-signing an auto loan is a decision that requires a lot of thought. Before co-signing an auto loan for a friend or family member, it’s important to consider your ability to make payments after a loan default and how it might affect your relationship.
If you have trust and confidence that the primary borrower will continue paying their monthly statements, you might decide to co-sign their loan application. If you agree to be on the loan contract, it’s important to review the loan documents closely.
You’ll want to consider your unique situation and relationship with the primary borrower when deciding if you should co-sign on an auto loan. With a certified financial planner, you might discuss how car loan co-signing could affect your credit eligibility. The average auto loan is between 67 to 69 months, depending on whether the car is new or used, meaning it will affect your loan eligibility for some time.
How to Co-Sign a Car Loan
You’ll need to meet a few requirements if you decide to co-sign a car loan for a family member or friend. Auto lenders typically prefer co-signers with good credit scores and sufficient income. You’ll usually have the meet the following requirements when co-signing a car loan:
A good credit report: Lenders expect the co-signer to have a good credit score. You can get a good credit score from a history of on-time monthly payments, a low debt-to-income ratio, and a long credit history. There are no set credit score requirements, but the higher the score, the better.Sufficient income: Auto lenders also evaluate the co-signer’s ability to make loan payments if the primary borrower defaults. They’ll calculate your debt-to-income ratio, including rent or mortgage payments, existing auto loans, and any other financial obligations.Employment history: Auto lenders consider not only a co-signer’s income but also their employment history. They might look at how long you have been with your current employer.
Once you agree to co-sign a loan, you must find a lender that accepts applications with a secondary signer. Both the primary and secondary buyer must fill out the application. This requires your contact information, employment records, and a copy of your credit report.
Many lenders allow for co-signers. Find the right lender by comparing rates among credit unions, banks, and dealerships.
Other Options When You Don’t Want to Co-Sign an Auto Loan
You might decide the loan term is too long or you’re not confident in the primary borrower’s ability to make payments. If you decide the risk is too great and don’t want to co-sign the loan application, it doesn’t mean you’re stopping that person from getting an auto loan. Additional resources might be available, even if the borrower has less-than-perfect credit.
Some lenders offer auto loans for people with bad credit. These loans often come with a higher interest rate, but it’s an option if someone needs a car right now. Unlike a co-signed loan, these auto loans are the sole responsibility of the borrower. If they stop paying, the lender reaches out to them for payment. Worst-case scenario, the lender repossesses the vehicle, which does not affect your financial situation.
Tips to Consider before Co-Signing a Car
Here are a few important things to consider before co-signing for a car:
Negotiate your responsibilities as a co-signer: Depending on the lender, you might be able to negotiate your responsibilities as a co-signer. Some areas of negotiation might include being responsible for the loan principal or your options for changing ownership if the borrower defaults.Calculate your ability to make the payments: If your close friend or family member stops paying, you might have to take over the monthly car payment to save your credit. Make sure you evaluate your own finances before agreeing to accept this liability.Consider the length of the loan: Some auto loans extend as long as eight years, making this a long-term financial commitment. You could be on the loan documents for almost a full decade.Evaluate the borrower’s ability to make on-time payments: Before agreeing to co-sign for a car, make sure you evaluate the main borrower and their ability to make payments on time. Late payments can have as much of a negative effect on your credit as not making payments.Make sure the primary borrower has sufficient car insurance: Without sufficient car insurance, you could be stuck paying the co-signed car loan, even if the vehicle is stolen or totaled. The good thing is insurance companies don’t care about credit as much as lenders do.Compare lenders: Just because you agree to co-sign the loan doesn’t mean you should skip comparing lenders. It’s best to choose a lender with the most favorable loan terms, which can increase the chances of the primary borrower making their payments.
Co-signing for a car is a big decision. Make sure you give it the careful thought and consideration it requires.
How to Remove a Co-signer from a Loan
It’s difficult, but not impossible, to remove a co-signer from a loan. Some lenders don’t allow borrowers to remove the co-signer without applying for a new loan. Your loan contract, however, might include a clause outlining the terms of removing a co-signer from an auto loan. This might require the primary borrower to have a specific credit score or ability to prove income.
The lender also typically requires the original borrower to maintain a history of on-time payments. They’ll carefully consider the borrower’s payment history and ability to pay the loan going forward. Refinancing the auto loan after a few years might also be an option. The primary borrower can improve their credit history, refinance the loan, and remove you as a co-signer. Knowing the requirements for removing yourself as a co-signer is important before agreeing to sign.
Taking out an auto loan is one of the biggest financial decisions you can make. A co-signed loan carries with it additional risks that could influence your own financial decisions going forward. You could end up having to pay if the initial borrower cannot make timely payments.
Before agreeing to co-sign an auto loan, make sure you have a clear plan for handling a defaulted loan.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.
