How a Car Loan Affects the Credit of a Cosigner
Here’s one of those things that are bound to happen to you at least once or twice in your life and will likely cause a bit of emotional discomfort:
A close friend or family member needs to buy a car but suffers from bad credit. They are in desperate need of someone to cosign their auto loan and, given that you are gainfully employed and possess a perfect credit score, they have of course come directly to you.
Your friend (or brother-in-law) assures you that it’s only a formality and promises never to get behind on the payments. You love and trust your friend (brother-in-law) and are inclined to go along. Before signing on, however, you need to know just what you are getting yourself into.
In the words of the Minnesota Attorney General Keith Ellison:
“The Attorney General’s Office has heard from grandparents living on fixed incomes who are hounded by debt collectors because a grandchild cannot find a job after graduation to pay back a student loan, from parents who cosigned a loan to help a child’s boyfriend or girlfriend only to be on the hook to repay the loan years after the couple has split up, and co-workers who cosigned loans for people they no longer work with."
The Bottom Line
Cosigning a loan is a generous act with potentially serious financial consequences. You generally should only cosign a loan if you have the ability and willingness to pay off the loan in the event the borrower defaults.”
Cosigning an Auto Loan: What Does It Mean?
Let’s be clear on what you are doing when you cosign a car loan. Cosigning a loan means that you are sharing full responsibility for its payment in much the same way as if you had taken out the loan for yourself.
A cosigner is not signing on simply as a character reference. Bluntly put, a cosigner is legally obligating to pay the loan, in full, if the primary borrower fails to make his or her payments.
How Cosigning a Car Loan Will Affect Your Credit
There are two primary ways that cosigning a loan can affect your credit:
Your credit score and record. Since you are obligated for the debt, a cosigned loan will show up on your credit report as if the loan was strictly your own. That means, for example, that if your friend (or brother-in-law) makes a late payment, a negative notation will appear on your credit report and your credit rating will go down. Keep in mind that since you are not the primary borrower and therefore do not receive monthly statements, you may not know that your credit score has dropped until some period of time later. Like when you apply for a credit card or go to purchase a house or car for yourself. And, as you might now expect, one or more payments missed entirely can mean a drastic drop in your credit score.
Your ability to get a loan. Speaking of applying for a loan of your own, cosigning for a friend (or brother-in-law) can create problems even if your friend (or, you know) has been perfect on his payments. That’s because the mere presence of the cosigned loan on your credit report can negatively affect your debt-to-income ratio, making it more difficult to procure any additional loans. Therefore, it is very important that you consider your own credit needs, both presently and in the future, before agreeing to cosign a loan.
A Few Things to Consider Before You Cosign
Keep records. Make sure that you receive copies of all loan documents. You may also want to insist that the primary borrower provide you with copies of all payment receipts and subsequent correspondence with the insurer. Remember, your credit score is on the line just as much as the primary borrower’s, so make sure that you stay informed.
Be prepared for the worst. Since you will be fully responsible for the loan debt if the primary borrower fails to make the payments, be sure that you have the financial assets available to cover the additional monthly expense that may result.
Concessions from the lender. You may be able to secure a few concessions from the lender before agreeing to cosign. For example, the lender may be willing to only hold you responsible for paying back the principal on the loan, and not for any late payment charges or other fees. You may also request that the lender inform you directly if the primary borrower is late or becomes delinquent in his or her monthly payments. The lender may deny your requests, but it does not hurt to ask.
An Unusual Time When Cosigning Can Be Good for Everyone
If you have no credit score and a financially-able close relative, you both may benefit from a cosigning arrangement.
In a case described by one of the major U.S. credit reporting bureaus, a lucky person with no credit (not bad credit, which is a different story) was able to find an auto loan for 0% interest -- if the loan was made in the relative’s name and with her as a cosignatory. In this example, the lucky person was able to start building a credit score because of the help of the trusted relative. If you find yourself in a similar situation, it might be worth discussing such a plan with relatives rather than despairing at the prospect of not being able to take out a loan at all.
Cosigning a loan is fraught with risk and can cause a lot of stress. If all goes well, however, it could also be a positive experience that strengthens personal bonds. Just be sure that you fully understand the potential pitfalls before you agree to cosign. And remember, if you are not completely comfortable with the arrangement, don’t be afraid to say “no.” You may end up saving an important relationship.
The Office of Minnesota Attorney General. "Cosigning a Loan," Accessed Nov. 30, 2019.