Imagine that you have your dream car picked out, you've found a great deal online, and you're ready to pull the trigger. You then take the logical next step of applying for a car loan, and out of nowhere, a denial status throttles your purchase. This is the unfortunate reality for car shoppers with compromised credit or no credit. Auto lenders see bad credit borrowers as high risk, and therefore, will either refuse to issue a loan or offer a very high interest rate to reduce the risk.
If you have bad credit, there are several options for purchasing a vehicle. You can pay cash outright, bite the bullet and pay the higher interest rates (if your loan is approved), or you can enlist a cosigner to help you get the financing you need and a lower APR. Having a cosigner can provide significant benefits when you're buying a car, but it also puts a big responsibility on you both. Here's how a cosigner can help, what requirements your cosigner must meet, and what his or her responsibilities will include.
Benefits of a Cosigner
Before we dive into what qualifies someone to cosign on a car loan, we'll address why you'd want to recruit one in the first place. Many shoppers with bad credit try to buy a car on their own first to avoid the uncomfortable conversation of asking for help from family or friends. The result is usually auto loan denial or approval for a very high interest loan. A cosigner can remove both of these roadblocks.
The most obvious benefit to enlisting a cosigner is auto loan approval, meaning you can get the reliable car you need for work and important errands. Other benefits include a potentially lower APR rate, and a larger loan amount depending on the cosigner's credit score and debt-to-income ratio.
Once you secure the loan with the help of a cosigner, paying it off will boost your credit score over time. Of course, this will only happen if you consistently make car payments on time. If you're late on a payment or miss a payment, you will harm your own credit as well as your cosigner's. However, if you're diligent about paying on time, every time, you can improve your credit and eliminate the need for a cosigner in the future.
Who is Eligible to Cosign for Your Car Loan?
When deciding who to ask to cosign on your auto loan, you'll want to factor in two important variables: your relationship with the person and their financial situation. A cosigner should be someone you know and trust such as a parent or an immediate family member. A friend, significant other, or distant relative can also cosign, but you should consider the effect on your relationship if you miss a payment and the lender calls them to collect the funds. When it comes to married couples with joint incomes, if one party has better credit, applying for a car loan as co-borrowers will be the best route to take for approval and lower interest.
The other part of the equation is your potential cosigner's financial status. The lender will look at the cosigner's credit score, and other factors like debt-to-income ratio, and proof of income to determine auto loan approval, amount, and interest rates. According to Experian, your cosigner should have a credit score of 670 or higher for the best chance of securing the loan.
The cosigner's debt-to-income ratio is important because it tells the lender whether or not the cosigner will have the funds to pay off your loan if you're unable. The debt-to-income ratio compares your cosigner's total monthly debt to his or her earnings. Lenders usually look for a debt-to-income ratio of under 50%. Proof of income is requested to ensure the funds can be collected from your cosigner to reduce the risk of issuing the loan.
Responsibilities of a Cosigner
When asking someone to cosign on your car loan, both of you have responsibilities that can make or break your financial futures and your relationship. Therefore, the decision of who to ask should not be taken lightly. Because the auto loan will be tied to your cosigner's credit until it is paid off, your role in the agreement is to make all your car payments in a timely manner. If you fail to do so, you not only further damage your own credit, but your cosigner's as well.
As soon as they sign the loan, your cosigner assumes responsibility for making payments if you're unable to. This means a lender can go after your cosigner after you miss even one payment. Your cosigner needs to be prepared to pay on your behalf or you risk having the car repossessed and your credit destroyed.
When asking a family member or friend to cosign your car loan, explain your situation and why you need their help. Make sure they are prepared with the qualifications needed for auto loan approval and that they understand their role throughout the entire loan term. If they meet the cosigner requirements and are comfortable with taking on the responsibility, you can proceed with the vehicle purchase.