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Becoming a cosigner can have serious financial consequences, especially if you’re hoping to buy a home.
When a friend or family member asks you to cosign on a loan, it’s hard to say no — especially if they need the money. We’re hardwired to help the ones we love, and cosigning seems like such a small favor to ask.
That feeling of guilt can be even more profound with a car loan because having access to a vehicle often means the difference between keeping a job or collecting unemployment checks. Who wouldn’t want to help their loved one stay on their feet?
But cosigning is more than just writing your name on the dotted line. So why exactly is cosigning so risky, and what can you do if you’ve already signed on to someone else’s loan? Here’s a breakdown to help you make sense of it all.
When someone applies for a car loan, they may be rejected for a number of reasons, like high debt-to-income ratio, a limited credit history, or bad credit.
If you can’t qualify for a car loan, a dealer or lender may suggest applying with a cosigner, someone with a much stronger credit profile or higher income. The cosigner’s credit score and credit history are used to boost the original borrower’s application. This can be a parent cosigning for their child, partner cosigning for their significant other, or just a friend looking out for another friend.
But being a cosigner means also taking on the legal and financial responsibility if the primary borrower defaults on the loan — without any ownership rights to the vehicle.
Cosigning on an auto loan can be risky because the lender has the legal right to come after the cosigner if the original borrower defaults. A cosigner who isn’t on the title is not legally allowed to take ownership of the car — even if the primary borrower stops making payments — which leaves them with no recourse except to pay the balance.
Cosigning is different from co-borrowing. As a co-borrower, both parties take shared ownership and responsibility for the loan jointly (aka a joint loan).
For example, a married couple who buy a house together may be co-borrowers and have equal claim to the home. When you cosign on a loan, you don’t always end up on the title as a co-owner. Cosigners who aren’t on the title do not have legal access to the property.
If you’re hoping to qualify for a mortgage loan soon, lenders will look at the following information (at least) to evaluate whether you can afford the loan and if you will make the monthly mortgage payments as agreed:
Lenders will ask for a lot of paperwork in the process to help them make a decision. If you’re self-employed, prepare to send even more.
Other factors come into play when applying for a mortgage (for example, how much you’ve saved for a down payment), but it’s your credit and income that could be at risk if you’ve cosigned a car loan.
Cosigning has a significant impact on your credit report. The loan will show up on your credit report as if you were the one who just bought a car.
“When you cosign a loan, it’s your loan,” said mortgage expert Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage.” “You are entirely responsible for it.”
The loan payments will be counted as part of your debt-to-income (DTI) ratio which is your monthly debt payments divided by your monthly gross income. If you’re applying for a mortgage, most lenders require that the total DTI, including any future mortgage payments, is 43% or less.
Let’s say you have a $500 monthly student loan payment, and your monthly gross income is $2,500 a month. This means your DTI ratio is 20%. If your boyfriend asks you to cosign on an auto loan with a $600 monthly payment, then your new DTI will be 44%. This could disqualify you from being approved for a mortgage.
“Auto loans are term installment loans and therefore have a greater impact on your score (for better or worse) than a credit card, and are taken more seriously if you have late payments or a default,” Fleming said.
If the original borrower misses a payment, it will show up as a missed payment on your credit report. Missed or late payments could result in a huge drop in your credit score, sometimes as much as 180 points.
If the worst should happen and the borrower defaults on the auto loan, it will count as a default on your credit report. This will likely disqualify you entirely from getting a mortgage. Even if you still qualify, you may be charged a higher interest rate on the loan.
You may have more luck if you’re applying for an FHA mortgage. FHA guidelines state that if the primary borrower has made on-time payments for the past 12 months, the payment will not be included in your DTI.
FHA loans also have lower credit score requirements and down payment minimums than conventional mortgages.
As the cosigner, you always bear the final responsibility in paying the lender. If the borrower defaults and the lender comes knocking, you’ll have no choice but to start making those payments.
This can wreak havoc on your budget if you can’t afford the payments. If you want to cosign for someone, make sure you can afford the payments — even if you’re certain they won’t default.
In general, you should be wary of cosigning for someone who doesn’t qualify for a loan through a traditional lender. If a bank doesn’t want to lend them money, it means they don’t have faith in the applicant’s ability to pay back the loan.
Even if the person who asks you to cosign is completely reliable, it’s impossible to predict what events may influence their financial situation. If they lose their job or run into an unexpected medical emergency, their ability to make payments may be hampered — leaving you on the hook for the remaining balance.
If you’re having trouble getting approved for a mortgage because you’re a cosigner, try these strategies:
Once you’ve cosigned for an auto loan, the best way to remove yourself is for the borrower to refinance the loan solely in their own name. This sounds simple, but it requires the borrower to qualify for a loan by themselves. If it’s only been a few months since the loan was originated, their credit score may not meet the necessary threshold.
To qualify for an auto loan refinance, borrowers generally need a credit score of around 660 or more. They can check their credit score for free on sites like Credit Karma.
The car’s loan-to-value (LTV) ratio is another key factor. The LTV is the remaining loan balance divided by the car’s value. Generally, lenders will have a maximum LTV of 125%, but this can be higher or lower depending on the borrowers credit.
For example, if the car is worth $9,000 and the remaining loan balance is $12,000, that equals an LTV of 133%. It would be difficult to find a lender willing to refinance this car, especially if their credit isn’t great. If the car is worth $9,000 and there is $8,500 left on the loan, then the LTV will be 94% and the car will be a good candidate for refinancing.
If the borrower doesn’t qualify for refinancing right now, have them apply again in six months when their financial situation may have improved.
Some lenders offer a cosigner release program, which removes the cosigner without refinancing the loan. Have the borrower ask the lender about this option before refinancing. This option is less common because removing a cosigner exposes the lender to more risk.
Although cosigning an auto loan is a risky choice, there are lots of reasons someone may still choose to do so. Try not to apply for any new credit leading up to the time when you do decide to submit that mortgage application. Keep in mind the risks involved with cosigning, and have a plan in place in case the primary borrower in case the borrower stops making payments.
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