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Cosigning an auto loan is a noble decision, but it can affect your credit if you’re not careful.
Volunteering to cosign an auto loan can help a friend or family member finance a vehicle purchase even if they have bad credit — or no credit history at all. By becoming a cosigner, you can leverage your good credit to help someone else stand up on their own two feet (or sit behind their own steering wheel).
But despite your good intentions, cosigning an auto loan can affect your credit and your ability to qualify for financing of your own. If you plan to apply for an auto loan or other type of credit (like a mortgage), you need to seriously consider whether you should cosign for a friend or loved one.
Fortunately, it’s not impossible to buy another car as a cosigner — you just need to understand how cosigning affects your credit and what to do to help yourself qualify for a car loan.
A cosigner is someone who agrees to take responsibility for a loan in the event the primary borrower — the person buying the car — doesn’t make loan payments.
When you agree to cosign an auto loan, the lender applies a heavier weight to your creditworthiness compared to that of the primary borrower. If you have a good credit score, you can help someone qualify for a loan even if they have poor credit — or none at all.
As a cosigner, you reduce the risk that the debt will go unpaid, even if the primary borrower defaults. This makes the bank or credit union more likely to approve the loan.
But that can be a double-edged sword, at least for you. Your responsibility as a cosigner means you agree to pay on the loan even if the primary borrower doesn’t. If you don’t, your credit will be negatively impacted as well.
However, cosigning a car loan doesn’t mean you’re a co-borrower: it’s not a joint loan. Additionally, you don’t own the asset purchased with the loan — the car — so you’re not able to make any decisions regarding the loan: your only responsibility is making sure it gets paid.
Your creditworthiness is impacted by factors that include:
Cosigning a car loan means you take on the responsibility for the debt, just as you would if you were the primary borrower. This is reflected on your credit report as an open loan. The addition of a new account, plus an increase in your total debt, can reduce your credit score.
As a result, applying for new lines of credit or qualifying for new loans as a cosigner can be more challenging, especially if you’re looking for the best loan terms.
It also contributes to your debt-to-income ratio, or DTI, a calculation lenders use to compare your monthly debt obligations to your monthly income. Though DTI doesn’t directly impact your credit, the higher your DTI the less likely a lender will approve you for financing.
Cosigning an auto loan doesn’t disqualify you from obtaining financing of your own — you can still get approved for an auto loan if you have a solid credit history and can afford your car payments.
However, being a cosigner can complicate your loan application process. Because a cosigned loan shows up on your credit report and contributes to your debt-to-income ratio, it can reduce how much “wiggle room” you have to pay for additional debt obligations — like a new car loan.
This happens because lenders use your DTI ratio to determine the affordability of a loan. If your DTI is too high — around 50% — you may struggle to get a loan from a traditional lender.
As a result, a cosigned car loan can make your financial situation less appealing to a bank or lender. Because you represent a higher risk by carrying this extra debt, the lender may not be willing to finance as much as you hope for. If the lender does approve the loan, it may have a higher interest rate to offset the increased risk you present.
Agreeing to cosign a car loan is risky, but you still have options to improve your ability to qualify for financing.
Start by looking at your current financial situation. How would it change if the primary borrower of a cosigned loan stopped paying, forcing you to start making loan payments? Would you need to make changes to your budget or would you still have surplus income?
Working through these figures will help you determine how much of a car you can afford. After accounting for your monthly debt obligations and expenses, how much is left over and where does that money fit into your budget? This amount can help you determine how much money you can fork over every month for an auto loan without risking late or missed payments.
If you can still afford an auto loan after looking at your financial health, it’s still beneficial to improve your chances of qualifying for an auto loan even as a cosigner.
Though you have responsibilities as a cosigner, you also have rights that entitle you to:
Understanding your cosigner rights can protect your credit (and your wallet) throughout the loan’s term.
Because lenders aren’t always required to send monthly statements and other notices to cosigners, you may not be aware that the borrower is missing payments or defaulting on a loan you cosigned.
Over time, these issues can add up to ruin your credit and, potentially, your finances. They can also make it difficult or impossible to qualify for an auto loan yourself.
Monitor your credit frequently by checking your credit report. Make note of any negative items and take action immediately to fix them, even if that means having a hard conversation with the primary borrower and explaining the importance of making on-time payments.
Credit can help you make purchases you couldn’t otherwise afford upfront, though with great power comes great responsibility. The more credit you use, the higher your credit utilization — one of the factors that impacts your credit score and overall creditworthiness.
In addition, applying for credit often results in a hard credit inquiry that remains on your credit report for about two years. Having too many hard credit inquiries can indicate your inability to properly manage credit and make it difficult to qualify for a new car loan, at least at the best rates.
Develop and practice good credit habits to improve and protect your credit by:
By staying on top of your credit, you can resolve issues before they arise and ensure your creditworthiness is in tip-top shape when it comes time to apply for an auto loan.
Lenders and dealerships sometimes require — or at least encourage — you to make a down payment before financing an auto loan. Making a down payment reduces the total loan amount you need to borrow, lowering your total monthly payment and the loan’s interest rate.
Additionally, forking over some cash demonstrates you have some skin in the game, reducing the risk you present to the lender and helping you qualify for an auto loan as a cosigner of another.
Cosigning an auto loan doesn’t entitle you to any control over the loan itself. However, you can offer recommendations and suggestions to the borrower.
If the borrower is responsible and making consistent payments on their car loan and other obligations, they’ve likely been steadily building and improving their credit. By demonstrating their creditworthiness, they can eventually apply for financing on their own without needing a cosigner.
This can be achieved by refinancing, meaning the original auto loan is replaced with a new one based on the borrower’s current creditworthiness. By refinancing, the primary borrower can apply on their own — or with a different cosigner — effectively freeing you from your responsibility as a cosigner.
As a bonus, they may also qualify for competitive loan terms, a better interest rate, and smaller monthly payments. It’s a win/win/win for everyone involved, helping you to apply for a loan yourself without being listed as a cosigner.
You can be removed from a cosigned auto loan by signing a cosigner release form, though there are some stipulations:
If all criteria are satisfied, your responsibility as a cosigner is removed after signing a cosigner release form. As a result, you can lower your DTI ratio and improve your likelihood of financing an auto purchase.
Cosigning a car loan is often an act of love or respect. By helping someone qualify for a loan they wouldn’t have alone, you may be helping them to get to work or school and establish and build their own credit.
But becoming a cosigner isn’t a decision you should take lightly. An irresponsible borrower can tank your credit through no fault of your own, making it difficult to apply for a car loan yourself.
Before signing on the dotted line, do your due diligence and only agree to become a cosigner if you trust the would-be borrower. Then, continue to monitor your credit and practice good habits to protect your financial health and the ability to continue qualifying for car loans as a cosigner.
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