For car buyers with less than perfect credit, getting a car loan can be a struggle. If you're in this situation, one of the easiest ways to get over the hurdle is finding a cosigner who has good credit and can sign off on the loan with you. If the shoe is on the other foot and you’ve been asked to cosign a friend or relative’s car loan, is it a good idea to oblige? We’ll break down the benefits of getting a car loan with a cosigner, explain the difference between a cosigner and a co-borrower and help you tackle the tough question of whether or not you should take on the responsibility for someone else.
Benefits of a Cosigner
Car shoppers with bad credit or no credit history often have a difficult time getting a car loan because the lender simply doesn't have confidence that they'll get paid back. If the applicant is approved despite their bad credit score, the loan will come with a high interest rate. A cosigner with good credit can swoop in and save the day by signing a contract stating they will make payments if the primary borrower isn't able to.
This car buying superhero will dramatically improve the odds of loan approval and can help bring down a sky-high interest rate to a more reasonable number. Typically, a credit score of 700 or higher will qualify a cosigner as having good credit. The lender may also look at the cosigner's income to determine approval and loan terms.
Auto finance lenders become much more 'generous' when you bring on a cosigner with good credit because the responsibility falls on the cosigner if you can't make your car payments. The cosigner must cover one or two missed payments or even the full loan amount if you stop paying entirely. While the cosigner won't have any legal ownership of the car, the lender sees them as a reliable way to get repaid.
Cosigner Vs. Co-borrower
Both a cosigner and a co-borrower can help a car shopper with bad credit or no credit get approved, but their roles are different. A cosigner will be responsible for repaying the loan as a backup if the primary borrow doesn't have the ability to pay but they don't have any ownership in the vehicle. Many times, parents will cosign for their young adult children when they don't have enough credit history built up.
A co-borrower, on the other hand, is equally responsible for paying back the car loan and has equal ownership in the car. A common example of a co-borrower situation would be a couple buying a car together. Both parties will sign the car sale contract, finance agreement and both names will be on the car title.
Should you Cosign for Someone Else?
From a young age, we're taught to live by the golden rule and to do onto others what we'd want to be done onto us. If you were in a pinch and couldn't get a car loan, you'd want a good friend or relative to help you out. Does that mean you should cosign for someone else? Not exactly. Your goodwill comes with serious risks which can affect both your bank account and your credit score.
Risks of Cosigning
The hard truth is that if your friend or family member is having trouble getting a car due to poor credit, there is likely a reason that they haven't been approved by lenders. It could be due to a history of late or missed payments or a low income that makes it difficult to stay consistent with payments. If they've struggled in the past, there's a chance they will miss payments on the car loan you cosigned, meaning you'll have to fork up the money yourself.
On top of having to reach into your own pocket in the event that the primary borrower can't pay, your credit score will take a hit when payments are missed. Another concern is that your debt-to-income ratio will increase which can impact your ability to get a loan for your own car or mortgage. If you want to help out a loved one, but don't want to take on the burden of cosigning, a good alternative is to directly lend them money for a car down payment. A large down payment such as 20% of a car's price can help someone get approved despite their bad credit.
When Should You Sign?
Even with the known risks, there are still good reasons to offer up your John Hancock for someone else's car loan. Maybe your loved one fell on hard times in the past but now is back on their feet financially and will have no problem paying off the car. If the car buyer is someone you entirely trust to make the loan payments in a timely manner or if you're helping someone with no credit history like your child, cosigning a car loan will make sense.