Whether you’re asked to do so by a family member or by a friend, before you cosign a loan, it is important to consider how making that decision may affect you financially. Your friend may have every intention to make the monthly payments on time, but if they don’t, you are just as responsible for the debt as they are. Both the borrower and the cosigner are legally responsible to make loan payments on a cosigned note.
There’s a lot to consider before you agree to cosign for a car loan.
Why Can’t They Qualify for the Car Loan On their Own?
There can be several reasons someone needs a cosigner. For example, if your child needs a car for work but hasn’t yet established a credit history, you may be willing to cosign an auto loan. After all, you know them, where they live, and what they earn. Another reason someone might feel they need a cosigner is because they want the best possible rate. They have a short credit history and a decent credit score, but you have a long credit history and a great credit score. You may qualify for a better interest rate. However, you may want to reconsider cosigning for anyone who has a poor credit score and a history of not paying their bills. You don’t want their bills to become yours.
Can They Make the Monthly Car Loan Payments?
When someone asks you to cosign their debt, you should consider asking some hard questions. How much do they earn? What do they spend? Do they live within their means? If the borrower is having difficulty managing their current expenses, they might have difficulty paying a car loan each month. If they have demonstrated inconsistency in paying bills on time in the past or inconsistency managing money wisely, you may be setting yourself up for financial obligations that are not a part of your current budget. On the other hand, if the borrower is gainfully employed and has a good money management history, you may feel comfortable cosigning the loan. Just note that if for any reason payments aren’t made on time, the lender will expect you to pay them.
Does the Borrower Have Money Saved for a Financial Emergency?
Everyone gets hit with an unexpected expense at one time or another, but you won’t want this to affect the borrower’s ability to make their car loan payments. Find out if they have an emergency fund before you cosign the loan.
Are You Willing to Risk Your Relationship?
Cosigning a loan is a commitment that requires trust and strong communication. If they pay on time, everyone’s happy because you’ve helped them in a time of need. Your act of kindness may even strengthen your relationship with the borrower. However, if they make late payments or default on the loan entirely, the transaction could harm your relationship.
Pros of Cosigning a Car Loan
- It could help the borrower establish a good credit history. This may lower the chance that they will need a cosigner for future loans.
- Your credit score may improve if payments are made on time, as on-time payments add a positive payment history to your credit report, as well as the borrower’s.
- The borrower may be able to get a lower interest rate in the future.
- It may assist the borrower in purchasing a car.
Cons of Cosigning a Car Loan
- Your credit score may be lowered a few points after the initial credit check.
- If the borrower does not make their monthly payments on time, both their credit score and yours will be lowered. If the loan remains unpaid and the vehicle is repossessed, your score may take an even greater hit.
- Unless you monitor the account each month, you will not know if payment has been made on time or not. The lender does not have an obligation to let you know if a payment is missed.
- This loan will be included on any debt-to-income ratio calculations that a lender will make on any of your future credit applications, and this may negatively impacting your ratio.
- Unless the borrower can qualify to refinance the loan to take over full responsibility for payments, you may find it difficult to remove your name from the loan.
There are some ways to protect yourself if you do decide to cosign a car loan:
- Request that the borrower to show you their monthly budget to assess if they will be able to make the loan payments.
- Don’t cosign a car loan unless you know the person is responsible with managing their money.
- Make sure you are granted online access to their account so you can confirm that payments are made on time.
- Set money aside in the event you do end up having to make the payments.
- Don’t cosign a loan for someone you’ve only recently met.