Perhaps you know a close friend or family member who needs to buy a car but suffers from bad credit. They are in desperate need of someone to co-sign their auto loan and, given that you are gainfully employed and possess a perfect credit score, they have, of course, come directly to you.
They assure you that it’s only a formality and promise never to get behind on the payments. You love and trust this person and are inclined to go along. Before signing, however, you need to know your hazards and obligations.
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 co-signed 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 co-signed loans for people they no longer work with."
Co-signing a loan is a generous act with potentially serious financial consequences. You generally should only co-sign a loan if you have the ability and willingness to pay off the loan in the event the borrower defaults.”
Co-Signing an Auto Loan: What Does It Mean?
Let’s be clear on what you are doing when you co-sign a car loan. Co-signing a loan means that you share full responsibility for its payment in much the same way as if you had taken out the loan.
A co-signer is not signing on only as a character reference. Bluntly put, a co-signer is legally obligating to pay the loan, in full, if the primary borrower fails to make their payments.
How Co-Signing a Car Loan Will Affect Your Credit
There are two primary ways that co-signing a loan can affect your credit. The first is with your credit score and record. Since you are obligated for the debt, a co-signed loan will show up on your credit report as if the loan was strictly your own. That means, for example, that if the borrower 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 do not receive monthly statements or see late payment notifications—you may not know that your credit score has dropped until some 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.
The second impact is on your ability to get a loan. Speaking of applying for a loan of your own, co-signing for someone else can create problems even if the primary borrower has been perfect on his payments. That’s because the mere presence of the co-signed loan on your credit report can negatively affect your debt-to-income ratio, making it more difficult to procure any additional loans. Therefore, you must consider your own credit needs, both presently and in the future, before agreeing to co-sign a loan.
A Few Things to Consider Before You Co-Sign
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 co-sign. For example, the lender may be willing only to hold you responsible for paying back the loan's principal, 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 Co-Signing Can Be Good for Everyone
If you have no credit score and a financially-able close relative, you both may benefit from a co-signing arrangement.
In a case described by one of the major U.S. credit reporting bureaus, a lucky person with no credit—not bad credit—was able to find an auto loan for 0% interest. The loan was made in the relative’s name and with her as a co-signatory. 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.
Co-signing 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 co-sign. 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.
Frequently Asked Questions (FAQs)
How do you get out of co-signing a car loan?
It may be difficult to get your co-sign removed from a loan when there's still a balance due. Since you originally signed the loan documents, you share the responsibility for that debt. The easiest way to get your name off of it is to have the other borrower refinance the loan with only their name on the refinanced loan. The original loan with your co-signing will be paid off during the refinancing process.
Who needs to be insured when a car loan has a co-signer?
The person who drives the car is the one who needs to insure it. In most cases, a co-signer won't need to be on an insurance plan tied to the car. However, since they helped finance it, the co-signer will likely care whether or not the car is insured. There are situations in which the co-signer is more likely to need insurance, such as when the two people who signed the car loan live together.