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Need a co-signer for your next car loan? Being asked to co-sign for someone else? We lay out the benefits and pitfalls of co-signing a car loan.
What Is a Co-Signer?
Let us say you have applied for an auto loan and your application was rejected, but the lender suggests that you stand a better chance of approval with a co-signer. So, what is a co-signer? A co-signer is another person who agrees to guarantee your auto loan. Effectively, they will be obligated to pay your loan if you are unable to. Their good credit acts as a buoy and helps you get approved for your auto loan.
Why You Might Want a Co-Signer
There are three principal reasons why you might want a co-signer for your auto loan. The first is having bad credit. With a low score you might have a tough time getting approved for a loan or, if you are approved, only for a small amount. Even with an okay credit score, you can still be denied a loan based on a high debt-to-income ratio or DTI, that is the amount of outstanding debt relative to your income. Thirdly, and perhaps most applicable for co-signing is a lack of credit history. Lenders are reluctant to extend credit to borrowers that lack a track record of consistent payments on other debt. So even if you have good credit and a low DTI, a limited credit history can still get you denied.
It is also important to note that a co-signer is different from a co-borrower. A co-signer is only taking on responsibility for the loan’s repayment, without any assumption of ownership. Alternatively, a co-borrower also agrees to guarantee the loan payment but will also share legal ownership of the car.
Before (And After) You Ask Someone to Co-Sign
Having someone co-sign for you seems like all upside, right? Obviously, you are asking a lot of anyone who agrees to co-sign a loan for you. Therefore, it behooves the borrower to have all the details in order before you ask. It will be important to know the loan amount, monthly payments, interest rate, and the term of the loan.
After that, step back and assess whether you really need a co-signer at all. Might you be approved for a smaller amount of money? If so, maybe you need to adjust your expectations to your current financial situation.
Also, shop around at different lenders. Some may not approve you without a co-signer while others will. With that said, pay attention to the interest rates lenders are proposing. Avoid being lured into a high interest loan because you are seeking a low payment or simply approval.
When you ask someone to co-sign you should game out scenarios with them in the event that you are unable to make regular payments. The surest path to avoiding disaster in this scenario is having a plan that is clearly laid out before both parties.
What to Know Before Becoming a Co-Signer
Let us take the flip side and explore important considerations to keep in mind if you are asked to co-sign a loan. Most often, it will be a family member who asks you to co-sign. For example, your high school or college-age kid lacks the credit history necessary for loan approval and needs a co-signer with good credit to help them get approved.
Ask yourself, how confident am I they can make the payments? Can I, as the co-signer, afford to make payments if the borrower fails to? You will (or should at least) have a good gauge of how “credit worthy” your own kid is.
If you are considering co-signing on an auto loan for someone there are a few things to keep in mind. Applying to be a co-signer will be just like applying for the loan yourself. This means a hard pull on your credit (which will temporarily ding your credit score). The loan will be on your credit thereafter, for good or ill. And that loan will raise your debt-to-income ratio (DTI). Any one or all of these factors could affect your ability to get credit yourself.
What to Consider Before Seeking Out a Co-Signer
As we outlined above, before you ask someone to co-sign for you, ask yourself whether you need a co-signer or merely want one to get approved for a larger or lower interest loan. Shopping around for a cheaper vehicle or a different lender might see you getting approved without help.
We offer this advice because asking someone to co-sign is a major financial obligation with the potential to damage your relationship if things go wrong. Unless you are asking a close family member, forget it. However strong your ties to friends or distant relations, financial entanglements are the perfect way to ruin a relationship.
Above all, be honest with yourself. Can you confidently make payments on the loan? If you have any doubts about your answer, do not ask a friend or family member to co-sign for you.
