Purchasing a new car can be tough for first-time buyers or those in challenging credit situations. The lack of credit history or any blemishes can lead really high-interest rates when applying for a car loan, or worse, not getting approved. In that case, many low- or no-credit buyers look to finding a co-signer to get the deal done. And if you happen to ever be asked to co-sign on someone else’s car loan, here is what you need to know.
What is a co-signer?
A co-signer is an individual that typically has good credit and agrees to help a borrower – who is usually in a challenging credit situation – apply for a loan in order to improve their chances of getting approved. Since lenders are looking for a borrower that has a good credit history, the thought here is that a co-signer with a good credit background will be able to hold the borrower responsible for the payments. If not, then the co-signer has to take responsibility for the loan.
Most co-signers are typically parents, relatives, or close friends of the buyer. However, a co-signer can technically be anyone that will agree to go in on a loan with the buyer.
Pro: A co-signer can get the buyer a lower interest rate on the loan
A benefit to co-signing on a loan is that you will not only help the buyer get approved for the loan, but if your credit is strong enough, then you can even help them get a lower interest rate.
Pro: A co-signer can help the buyer establish their credit history
If you’re planning to co-sign on a loan, then the good news is that you’ll be helping the buyer establish their credit as well. As long as the buyer makes all of their payments on time, their credit situation should improve and it will keep yours in good standing as well.
Con: The co-signer is responsible for the loan if the buyer can’t make the payments
On the flip side, if the buyer misses payments on the loan, then it will negatively impact the co-signer’s credit history as well. Bear in mind that any missed or late payments can show up on the co-signer’s credit report. Credit Karma notes that if the buyer defaults on the loan altogether, then the co-signer could be on the hook for the remainder of the loan.
Con: A co-signer can’t opt-out of the loan freely
If you do co-sign on a loan then you might think that you can just opt-out of it freely if you change your mind or things start to go bad. Unfortunately, that’s not the case, and once you’ve signed the loan agreement, the deal is done.
One way to protect yourself would be to agree with the buyer that if they make the loan payments on time and their credit situation improves, they can refinance the loan and take you off of it. Otherwise, as a co-signer, you should be ready to be in it for the long haul.
As a co-signer, budgeting for the worst-case scenario can help
If you do end up co-signing on an auto loan, the best thing to do would be to budget your monthly income to accommodate the monthly car payment should you have to pay for it. Although you’re not actually the one making the payments, ensuring that you have enough money to pay the car loan, if the buyer defaults on it, is a good way to make sure that you don’t suffer from the situation.
Either way, it’s a good idea to come to some type of agreement with the buyer to make sure that both parties are satisfied with the situation and no one gets short-changed. After all, you’re helping out a friend or family member in their time of need, you should make sure that you’re needs are covered as well.