Everything You Need to Know about Cosigning on a Car Loan
If you’ve been graciously talked into cosigning on a car loan by a family member or close friend, it’s a good time to weigh the benefits for your loved one and the risks for yourself.
Cosigning can be problematic when the other signee has a bad relationship with responsibility and finances. If he or she defaults, either you have an obligation to pay or your credit will get dinged. In the end, everyone on the loan is reported to the credit bureau.
Before jumping into a pro and con list, take a breath, and let’s go over some details of the cosigning process.
What is the Difference between a cosigner and co-borrower?
Finance terminology can be a bit confusing, and you may find yourself wondering what title you are signing up for. When it comes to a housing loan, a co-borrower is someone who is equally responsible for the loan and a co-owner of the property.
A cosigner is someone who signs the loan after there has already been an application submission and agrees to pay what the primary loan holder is unable to, but does not have ownership of the property.
When cosigning on a car loan, the rules shift. Robert Janssen, sales manager at Innovative Funding Services (IFS), has this to say about it:
In our auto financing realm, we have slightly different views of these terms. A co-borrower is essentially your spouse/partner. In the eyes of the lender, a married couple are viewed as one entity, and viewed as less risky. A cosigner is someone else besides your spouse/partner, such as sibling, parent, friend, etc.
But this cosigner is equally responsible for the vehicle as the primary applicant. So if the loan is past due, the cosigner gets the same negative affect on their credit as the primary applicant.
Also, this debt is added to their overall debt for the debt-to-income ratio, which can hurt them if they apply for other loans in the future. Using this terms, a bank generally views cosigners as riskier than co-borrowers. But banks would rather have two people on a loan than one, because there’s more people to go after in the case of a default.
What are the risks of becoming a co-signer?
There’s no question that you must have a kind heart to consider helping out your friend or family member obtain a loan. Unfortunately, the risks tend to outweigh the rewards of cosigning.
Aside from potentially having a negative mark on your credit history – and in the worse case scenario, getting sued by the lender for ignoring payments – your personal relationship may suffer. What may be a solid and loving bond between you and the loan-borrower may suddenly become very fragile, even hostile, when your personal finances get harmed.
Janssen provides an example of a client who was negatively affected by her experience as a cosigner:
I went through the application and credit, and I noticed everything was perfect except for a second auto loan under her name. The auto loan was two payments past due, near repossession status, and dropping her credit score tremendously. When I asked her about it, she said that was her brother’s vehicle. I told her to have it caught up and call me back in a few months. She did, and her credit improved. But those late payments will still hang on her credit and won’t drop off for ten years.
Imagine if that was her friend. They might not be friends after that.
I’ve spoken to many cosigners where their primary applicant stopped making payments on their car notes, and now they’re credit and debt-to-income ratios have taken a hit. And those cosigners may not have budgeted to pay that extra car payment.
If those cosigners apply for a mortgage or another car for themselves, that cosigned loan may prevent them from adding any more debt to their name.
Questions to Ask Yourself before Cosigning on a Car:
- Do you trust the loan holder?
- Is the loan holder generally responsible?
- Does the borrower have a good track record with bill paying?
- Do you have the financial capability to take over payments if the loan-holder defaults?
- Do you have the time to make sure the borrower is making payments?
- If your credit gets dinged, will it also ding your relationship to the borrower?
- Do you plans that will require you to take out more loans in the near future?
- Does the borrower’s home addresses change often?
If you’ve addressed all of these questions and still want to move forward with cosigning, consider the biggest golden-heart question of all:
How are you helping the borrower?
What Are the Benefits of Co-signing?
If your child has just graduated school and hasn’t had enough experiences to establish a solid credit score, it’s going to be tricky to find a lender without a cosigner. That quivering bottom lip is a straight-shot to your wallet, or in this case, your pen. By cosigning this loan, you are giving your child the chance to build credit as well as the opportunity to discover the reality of responsibility. That life lesson in itself may be worth the gamble of cosigning.
By cosigning, you are also helping the borrower potentially obtain a lower interest, reducing his or her monthly payments. If the signee had a rough start and accumulated bad credit over the years, you are giving your lucky friend or family member a second chance. To some golden-hearts, that is worth all the risk.
Are you a cosigner on an auto loan and want to be removed from the account? Talk to the primary loan borrower about refinancing the loan solely under his or her name and save your credit and relationship!
IFS offers competitive rates and will work hard to find the borrower a shiny new loan.