If you have a bad credit report, you may find it challenging to qualify for a car loan. And if you do, chances are you’ll get unfavorable loan terms with high-interest rates. Applying for an auto loan with a cosigner can improve your approval odds and potentially help secure a lower rate.
Whether you’re looking for a cosigner or a family member, or a close friend has asked you to cosign a car loan, it’s crucial to understand how cosigning works and its impact on your finances before taking the plunge.
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How Does Cosigning for a Car Loan Work?
Lenders or leasing companies typically require loan applicants to have a cosigner if their credit scores and income don’t meet certain requirements. Having someone cosign a car loan is a way for anyone with bad or no credit to secure a loan by having a cosigner put their name on the loan documents.
Cosigning for a car loan is accepting full responsibility to pay off the loan if the principal borrower misses or defaults on loan payments. Unlike co-buying or co-borrowing, cosigning does not give the ownership rights of the vehicle. Instead, the cosigner is legally responsible for repaying the loan balance if the primary borrower defaults on the loan.
Many people think that cosigning a car loan simply serves as a character reference for the principal borrower. But there are a lot of risks involved, especially how it will impact the finances of both parties. For one, the lender is legally entitled to pursue the cosigner for the loan, late fees, and repossession costs if the primary borrower defaults on the loan.
That said, cosigning for a car loan may seem like a bad idea in one situation but a good idea in another scenario. If you choose to cosign an auto loan for your loved one, you must carefully weigh the potential outcomes before committing yourself.
Things to Consider Before Cosigning on A Car Loan
Cosigning a car loan comes with costly risks. Here are some of the things you should consider before devoting yourself.
Your Ability to Repay the Loan
As a cosigner, you’re not only vouching for a borrower’s ability to repay the loan. Instead, you’re taking full responsibility to pay off the loan. If the primary borrower misses monthly payments and defaults, you’re legally responsible for paying back the loan. So before taking the plunge, ask yourself if you can comfortably cover the monthly payments now and in the future.
Your Relationship with the Person
As much as you’re willing to help your loved one by cosigning a car loan, your relationship could suffer if things don’t go as planned. Whether you’re cosigning for your spouse, family member, or friend, checking routinely to ensure that they are making monthly car payments could also affect your relationship. If you don’t want to risk losing your relationship, cosigning might not be a good idea.
How Car Loans Affect Cosigners Credit Scores
When you cosign a loan, it will appear on your credit report. If the borrower stops making payments, your credit score will take a hit. Even worse, it could also affect your ability to borrow and get approved for a loan in the future.
Pros and Cons of Cosigning on a Car Loan
As with any other financial product, cosigning a car loan has upsides and downsides. Weighing the pros and cons of cosigning a car loan will help you decide.
Pros of Cosigning on a Car Loan
Here are some of the benefits of cosigning a car loan:
- Establishing or rebuilding your credit score: Whether you’re cosigning a loan or someone is helping you improve your approval odds; it gives you both a chance to establish or rebuild your credit score. If the borrower makes timely payments each month, both of you can see your credit scores rise.
- Improving your chances of approval: As someone with a bad credit history, creditors will always see you as a high-risk borrower. Having someone cosign a car loan for you is a way of helping you improve your chances of loan approval. Lenders are more willing to approve the loan because your cosigner legally takes the responsibility if you default.
- Accessing lower interest rates: Another benefit of having someone cosign a car loan for you is the ability to qualify for lower interest rates. A cosigner with good credit can secure you lower rates, meaning lower monthly payments.
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Cons of Cosigning on a Car Loan
While cosigning has many benefits, it comes with drawbacks too:
- Sharing credit score risks: The loan typically shows up on the cosigner and the borrower’s credit report, meaning both parties will share the risk. A missed payment will negatively impact your score and that of the borrower. As a cosigner, you may find it challenging to obtain financing for your personal needs.
- Responsibility if the borrower defaults on payments: As with any other loan, defaulting on monthly payments always comes with risks. In the case of a cosigned auto loan, the cosigner takes full responsibility to pay back the loan if the borrower misses or stops making monthly car payments. Apart from that, you’re also responsible for paying late fees and collection costs.
- The inability to open new lines of credit: One of the key aspects creditors look at when assessing loan applications is the borrower’s DTI (debt-to-income) ratio. If your DTI ratio is high, lenders will hesitate to lend to you even with an established credit history. And if they do, you’ll likely pay a high-interest rate on the loan. The bottom line is that you won’t be able to open a new line of credit, whether personal or home equity, if your DTI ratio gets too high.
- Removing the cosigner from the loan: When you cosign a loan, you’re on the hook for the entire loan. While you can remove yourself as a cosigner, it’s not as easy as you think. Generally, lenders are reluctant to remove a cosigner because withdrawing the name of the loan documents increases the lender’s risk. The only way to remove a cosigner from a loan is to pay off the loan amount in full. Sometimes this can be done through refinancing, although it does require the other person on the loan to be creditworthy enough for a new loan or to find another cosigner.
Alternatives to Cosigning on a Car Loan
Cosigning a car loan isn’t meant for everyone. If you asked your friend or family member to cosign an auto loan for you but weren’t pleased with the idea, here are alternatives to consider.
Use Your Credit Card
One of the most popular ways of financing high-ticket purchases for many Americans is using a credit card. It is possible to buy a car with a credit card, provided that your credit limit is high enough. However, credit cards typically have high annual percentage rates (APR), and you may end up paying much more in interest.
Ask About Trade-In Value
You might also want to consider asking about trade-in value from car dealerships if you have an old car. Trade-in value is the car dealership’s valuation of your existing car if you opt for a trade-in. When you trade in your car for a new one, you can use the trade-in value as a down payment, which reduces the amount you need to finance.
Consider Refinancing to Save for Your New Car
Another alternative to cosigning a car loan is refinancing through an online lender like Auto Approve. On the flip side, Auto Approve can also help you refinance to add or remove a cosigner from your existing loan.
Auto Approve works with a network of credit unions and banks to ensure that you get the best APR on auto refinance. Apply for Auto Approve vehicle refinance to get competitive rates, starting from as low as 2.25%.