Experts say not to apply for credit before buying a house. But does this apply to car loan refinancing? Refinancing your car can help you snag a lower interest rate and a lower monthly auto loan payment. But depending on your credit history, refinancing your car right before buying a…
Guaranteeing an auto loan as a cosigner may seem simple, but there are a few key details to keep in mind.
Financing a vehicle can be a tough process if you have a limited credit history, derogatory reports, or are just getting started in your career. In some cases, getting approved for an auto loan might require asking someone — like a parent — to cosign on the loan for you.
If you’re a parent who has been asked to cosign on an auto loan with your child, you may have a lot of questions. Let’s talk a bit about what a cosigner is, where their financial responsibility lies, and whether adding your name to someone else’s debt is a bad idea.
What is a Cosigner?
A cosigner is someone who agrees to sign on and take responsibility for someone else’s debt, if they fail to maintain the terms of that account as agreed. As a cosigner, you can add your name to a loan belonging to your child, another family member, or even a close friend.
They will be considered the primary borrower, but as the cosigner, you also assume liability for the debt. If payments are made late or the loan is defaulted upon, you will be held liable along with the borrower.
Cosigner vs. Joint Applicant vs. Co-Borrower
A cosigner is different from a joint applicant, or co-borrower, in a few important ways.
As a joint applicant, also called a co-borrower, two or more people agree to apply for and take on a debt together. They share the benefits of the loan while also sharing equally in the liability. This is the case when a husband and wife take out an auto loan or mortgage together, for instance, and they are considered equal parties in the contract.A cosigner, however, is there to secure the debt itself rather than to be an equal party in the process. As the cosigner on an auto loan, you are unlikely to receive updates about the financed vehicle or even its payment status, in many cases. However, if the debt is not paid for any reason, you will be responsible for the amount owed.
Why You Might Consider Cosigning
Whether your child is wanting to buy a new or used vehicle, it’s highly likely that they will finance the transaction. In fact, around 85% of new and 54% of used car purchases were financed in 2019.
However, some buyers may have trouble financing their car purchase for a variety of reasons. They may need to turn to a cosigner in order to get the loan they want.
One of the most common times that a car-buyer might need a cosigner is when their personal credit alone isn’t enough to qualify for a good loan. This is especially true when talking about young adult children, many of whom have limited credit histories, student loans, and/or higher debt-to-income ratios.
Before deciding to cosign an auto loan with your child, see where their credit stands. There are many places that they can check their credit report for free, giving them an idea of their personal creditworthiness. If they have derogatory reports, a high debt burden, or simply don’t have a long enough credit history, you might want to consider cosigning.
Some lenders have very specific income requirements before they will approve a borrower for an auto loan. Your child may not meet these requirements, especially if they are still in school or just starting their career.
If your child does not have a high enough gross income to qualify for their new vehicle loan, you may need to cosign in order to push the loan through.
Another good reason to add a cosigner to a loan is if doing so would allow you to qualify for a better interest rate. When cosigning for your child or another close relative, adding your name to a financed vehicle could mean hundreds — or even thousands — of dollars saved in interest over the life of the loan.
For example, a $20,000 vehicle financed for 60 months at 6% will cost you about $3,2000 in interest charges over five years. However, that same vehicle financed at a 3% interest rate instead will only cost you about $1,500 in finance charges.
By adding a creditworthy cosigner to their auto loan, your child increases the chance of getting more desirable loan terms… and possibly, some considerable savings.
Should I Cosign an Auto Loan for My Child?
If you’re considering cosigning an auto loan for your child, you’re not alone. In fact, a 2016 CreditCards.com co-signing survey found that 45% of cosigners agreed to add their name to a loan for their child or stepchild. (Only 21% of cosigners did so for a close friend, however.)
But just because agreeing to be a cosigner is commonplace, that doesn’t necessarily mean it’s a good choice for every parent. Let’s take a look a some of the pros and cons of adding your name to someone else’s loan.
Benefits of Cosigning
As parents, we want to do everything in our power to help our children, which is why you may be considering a cosigned loan in the first place.
There are many benefits when you agree to back a loan for your child (or relative or close friend):
- It helps them secure the loan. Depending on your child’s credit history and income, your name on the loan might mean the difference between approval and denial.
- They may get better terms. Even if your child qualifies for the loan on their own, adding another creditworthy borrower (you) could open the door to better loan terms, such as a lower down payment or interest rate.
- It can add to your credit history, too. As long as your child makes their payments on time each and every month, the positive account can further boost your own payment history.
Risks of Cosigning
Of course, there are a few very important risks to consider before you sign on that dotted line. Depending on your child’s particular circumstance — and financial habits — cosigning could be disastrous.
- The loan could adversely affect your credit report. Adding another installment loan to your credit report could increase your debt burden and debt-to-income ratio. If you plan to make a big financial move in the near future (such as a mortgage refinance), this could a big negative.
- Your credit score could drop. Between a hard inquiry, new account, and increased total debt, cosigning on an auto for your child could easily drop your credit score.
- You’re responsible for the debt. Even though it’s your child’s vehicle and they are the primary borrower, adding yourself as a cosigner means that you also guarantee the debt. If your child makes late payments or even defaults on the loan, you (and your credit report) will also feel the effects.
It’s important to know exactly where your child stands in terms of being responsible enough to manage their debt and being truly able to afford their new vehicle. Even the best kids could hit rough times or make a mistake — and you’ll be on the hook right along with them.
In fact, according to the CreditCards.com Survey mentioned above, 38% of cosigners had to pay some (or all) of a cosigned loan back after the primary borrower failed to make on-time payments. Are you financially (and emotionally) prepared for that possibility?
How to Get Out of a Cosigned Loan
So, you signed on a loan for your child or someone else, and are now ready to get your name off the debt. Is there a way out?
Whether you are worried about the primary borrower managing the debt responsibly or simply think it’s time they took over for themselves, one of the best ways to get out of a cosigned loan is to refinance.
By refinancing an auto loan, your child is able to release you from the debt while also potentially scoring better finance terms. Their credit may have improved since you first cosigned on the debt — especially if they’ve been making timely payments each month since then — and they are probably able to now qualify for their own loan. This new loan could even have a shorter repayment term, lower interest rate, and/or better monthly payment amount.
Additionally, some lenders will allow for cosigner release after a specific period of time, though this is not as common. A refi is often a better decision as it allows your child to shop around and take advantage of better loan offers.
Alternatives to Cosigning
Whether you’re uncomfortable with cosigning on your child’s auto loan or are planning to make a big purchase in the near future and need to keep your credit squeaky clean, there are a few alternatives to consider.
The first is to help your child develop a solid savings plan. If they are looking to buy a vehicle before long, help them create a game plan for saving the down payment (if not the whole purchase price). You can even help them shop around for the best places to tuck those savings, so they can earn the most interest while it builds.
You could also offer to lend them money for a down payment on their new car. Sometimes, lenders are more willing to work with borrowers if they have a notable down payment available. You can give this to your child as a gift or as a loan to be repaid, but it may help them qualify for an auto loan on their own.
Lastly, you can help your young adult child by educating them and building their credit early on. This may mean teaching them how their credit works, walking them through their first credit card, or even adding them as an authorized user on your own credit card. Then, when they are ready to purchase a car on their own, they will have a positive credit history already built up.
If your child is having trouble qualifying for a good auto loan on their own, adding yourself as a cosigner may seem like the perfect solution. And while this may be enough to not only get the loan approved but even snag better loan terms, there are a few important details to keep in mind along the way.
Before you ever sign on the dotted line, be sure that you are confident in the primary borrower’s ability to responsibly manage the debt. After all, it’s your hard-earned credit history that’s at-risk, too.