To cosign, or not to cosign. That is the question. While cosigning an auto loan for a friend or family member can help them get a car they might not be able to afford on their own, you could be taking on undue risk. As the cosigner, you’re agreeing to pay the amount due and perform all the agreements stated on the contract if the borrower fails to meet contractual obligations. You’re on the hook for the loan payments if the other person stops making them for any reason. Even if they die.
As the cosigner, you’re essentially the loan company’s Plan B.
Sometimes, the risks of cosigning for someone don’t outweigh the rewards, even if the person is your [insert relationship here!]. Here’s when you should think twice about cosigning an auto loan.
Think twice about cosigning a loan when…
You’re planning on making a major purchase soon.
Considering renovating your home, buying an investment property, or purchasing anything that might require credit? Then be careful. Being a cosigner could ding your credit in two ways.
First, if the other person fails to make their auto loan payments on time, your credit could be damaged right along with theirs.
But let’s say they never miss an auto loan payment. There’s another risk to consider, too.
Cosigning an auto loan will increase your debt-to-income ratio, which is the percentage of your debt payments in relation to your income. Any auto loan you cosign for will show on your credit report, even if the financed car isn’t yours and you never get to drive it. New lenders will review your debt-to-income ratio when you apply for financing, and they might not be too excited when they learn you could be on the hook for someone else’s auto loan.
“Because you’re liable for [the loan’s] balance in the event of a default, being a cosigner can decrease your ability to get new credit,” says Money Crashers.
It doesn’t matter if the other person makes their payments on time. “Cosigning a loan can also lower your credit score because the amounts you owe makes up 30% of your FICO score,” adds Money Crashers.
According to Smart Assets, a debt-to-income ratio of 36% is generally accepted as good. The closer you get to 36%, the more your credit score could drop and the more hesitant a potential lender might be. Keep your debt-to-income ratio low for less stress and more credit opportunities.
Your relationship with the borrower is rocky.
You may feel tempted to cosign for a loved one to show them you care, to help them out of a tough time, or because you feel guilty for things that happened in the past. These feelings are completely normal and understandable.
Keep in mind, however, that cosigning a loan could make your relationship worse, not better. When you turn a personal relationship into a financial relationship, you put a lot of undue stress on the personal relationship.
“You’re putting your relationship in real jeopardy,” Megan McArdle, business and economics editor for The Atlantic, told NPR.
McArdle explains, “If you become this person’s primary creditor, which is what’s going to happen if they default, that really damages the relationship. And even if you don’t, you know, as Dave Ramsey, the financial guru, likes to say, Thanksgiving dinner tastes different when your father-in-law is asking – is looking at you across the table and wondering why you couldn’t pay off your car loan and yet you have a TV or whatever. Keeping those kinds of decisions outside the family, outside of relationships is usually better for everyone in the long run.”
There are libraries of information about the psychology of money, and especially around money and family. Don’t put your most important relationships at risk by cosigning a loan.
Remember that cosigning a loan means:
- You’ll be responsible for the loan.
- Your credit could take a hit.
- You’ll have difficulty financing your own purchases.
Are these risks you’re ready to take?
You can help in another way.
Having a friend or family member cosign is one way many drivers are able to get car loans with little to no credit, but it’s not the only way. You can help a loved one get behind the wheel of a new or used car by:
- Helping them build better credit. Can you help them set a budget, stick to it, and improve their own credit situation? It might not take as long as you think. Teach your loved one how to build their own credit and you’ll be doing them a favor for years to come.
- Gifting them money for a bigger down payment. Making a bigger down payment means they’ll need to borrow less, and this could make a car loan easier to get with poor or no credit.
- Comparing auto financing options. Their first option might not be the best financing option, especially if they’re trying to get a car loan with minimal credit. Different lenders offer different loan terms and interest rates. Encourage them to shop around. Another lender may not require a cosigner!
If you have a friend or family member asking you to cosign a loan with them, there’s a chance they simply haven’t done their research. Have they compared all available loan options? Have they researched how to qualify for an auto loan? We can help. Encourage your loved one to try myAutoloan, where we present applicants with up to four auto loan offers at once. We even work with applicants who have bad credit… which could help keep you out of a bad cosigning situation.