It’s not the zombie at your door that’s sending chills up your spine. It’s your auto loan payment. As dusk settles on your neighborhood, a shrill wail shatters the evening’s peace. Goosebumps rise along your arms as you hurry your way inside, closing and locking your door behind you.…
Cosigning a car loan may seem like a good deed, but can lead to bad credit if you’re not careful.
For many of us, a car is a necessity, a means by which we get to and from our jobs, shop for groceries, and even relax. Despite the near-necessity of car ownership, it’s not always easy to qualify for an auto loan.
An incomplete or bad credit history can make it difficult to finance a car purchase. In some cases, taking out an auto loan might be downright impossible. That’s when many people ask a family member or close friend to cosign their car loan.
But cosigning a car loan isn’t without risk. A 2016 CreditCards.com poll revealed one in four cosigners had their credit damaged by cosigning for a loan or credit card, and one in three found themselves paying the loan or credit card.
If you’re planning to cosign a loan, or have already done so, understanding your cosigner’s rights can help protect your financial wellbeing and creditworthiness.
What is a Cosigner?
A cosigner is a person who accepts the responsibility of paying a loan and adhering to its terms if the primary borrower — the person taking out the loan — fails to do so. Cosigners are often useful or necessary when someone with insufficient or poor credit history applies for a loan.
Because the lender takes the cosigner’s creditworthiness into account when deciding whether to offer a loan, the primary borrower may qualify for a loan they would otherwise not qualify for on their own — and may even be offered more favorable terms than applying alone.
A cosigner’s credit score must typically be “670 or better,” says Lauren Blair, a lawyer with FreeAdvice.com with over 25 years of experience in contract negotiations and litigation.
In addition to good credit, Blair emphasizes that cosigners “must show a reliable source of income to cover loan payments in the event the primary borrower defaults.”
Put more simply, you promise to pick up the slack if the borrower stops or can’t continue to pay the loan.
Cosigner vs. co-borrower
Cosigners are not borrowers. Cosigners aren’t entitled to the loan’s funds, nor what the funds are used to purchase. In the case of a car loan, you will not be listed on the title and have no property claim over the vehicle.
A co-borrower, or joint applicant, is someone who receives the benefits of a loan. They’re responsible for all the same obligations as the primary borrower, but are also entitled to all the same benefits.
Co-borrowers share ownership rights of what the loan purchases. Both the borrower and co-borrower(s) will be listed on the vehicle’s title and loan documents, whereas a cosigner is only listed on the loan.
How your credit is impacted when you cosign a loan
Cosigning an auto loan impacts your credit report in much the same way taking out a loan yourself would. As such, your credit report will show the cosigned loan’s payment history, including:
- Late payments
- Missed payments
- Loan defaults
- Collections accounts
Of course, you don’t need to worry about negative factors if the borrower (or you) continually makes on-time payments as agreed.
Even if the loan you’ve cosigned is in good standing, it still increases your debt-to-income ratio. This can make it more difficult to qualify for a new auto loan or refinance, mortgage, or personal loan, at least with as favorable an interest rate as possible.
Your Responsibilities as a Cosigner
Cosigning a car loan isn’t a mere formality to help someone qualify for a loan they’d otherwise not be approved for. By cosigning for a loan, you guarantee the debt in the event the primary borrower doesn’t make good on their obligation.
To meet this requirement, you need to make sure you can afford to pick up the tab if the borrower stops making payments. You shouldn’t agree to cosign a loan if payments don’t fit within your budget or financial situation, even if you think such a situation is unlikely.
Depending on your relationship with the borrower, you might, instead, agree to take full responsibility for making some or all of the payments. Because the loan affects both the borrower’s and cosigner’s credit, this sort of arrangement can help you build or boost the credit of your child or grand — and help them get from point A to point B.
Remember: Although you, as a cosigner, are equally responsible for an auto loan, you’re not entitled to the car itself. The car title belongs to the borrower and any co-borrowers alone.
What Happens if a Borrower Defaults on an Auto Loan I’ve Cosigned for?
A loan default occurs when the borrower stops making payments on their loan. When a car loan defaults, the lender will do everything in its power to try to collect on the unpaid portion of the loan’s principal and interest, including holding the cosigner responsible for paying the debt.
Because you’re just as responsible for paying the loan as the borrower, this means the lender will begin to pursue you to make good on the debt. At the same time, any late or missed payments will begin to accumulate on your credit report and drive down your credit score.
If you refuse or fail to pay the loan, the lender will seek to recoup its losses by repossessing the car which served as collateral when taking out the loan.
Finance companies and dealerships typically list repossessed vehicles at auction, which means you’ll likely need to deal with a deficiency balance — the amount you still owe on the loan after the auction’s sale price has been deducted from it.
The lender may also choose to “pursue legal action if the loan remains unpaid, which means the possibility of garnishing your bank accounts or wages,” warns founder of The Income Finder Paul Weaver, an expert with over 15 years of experience in banking and finance.
You may also be required to pay any accumulated late fees, court costs, and other penalties beyond the loan amount.
Cosigner Rights After Cosigning on a Car Loan
It goes without saying that allowing an auto loan you’ve cosigned to default is bad news bears. Understanding what rights are available to you as a cosigner can help you limit the damage done to your credit and bank account.
Notices and statements
As a cosigner, whether the finance company sends you the same notices and statements it sends the borrower varies by state. In fact, in most cases, lenders don’t have to send statements or give any account access to cosigners — though they will send collections notices. You may not even receive a notice of repossession once the loan defaults.
Once the car’s been repossessed, you’ll receive information about your legal rights as a cosigner. Though the specific rights vary from state-to-state, the lender will let you know how you can:
- Redeem or buy back the vehicle, typically by paying the outstanding balance and any fees (such as storage, auction, and attorney fees)
- Buy the vehicle back at auction
- Reinstate the loan contract by paying off the past due balance to make the loan current once again
In all instances of repossession, the lender must sell the car in a “commercially reasonable” manner. What exactly constitutes a commercially reasonable sale depends on the standard sales practices in your area, restricting the lender from taking any unreasonable or underhanded actions, such as scrapping a car that still has value or failing to advertise its listing at auction.
Following the sale, the lender must provide you with information related to the sale and its proceeds, including notification of any deficiency balance (what you still owe on the loan) or surplus (if the vehicle sold for more than was owed on the loan).
You may be given priority over the borrower in the event of a surplus payment. Look over the loan contract to determine who is entitled to any potential surplus.
If the lender fails to conduct a commercially reasonable sale, you may be able to pursue a lawsuit against the lender for damages or contest a judgment requiring you to pay the deficiency balance.
Ownership during repossession
Cosigners aren’t on the vehicle’s title, even if they’re on the loan documents. You don’t own and aren’t entitled to ownership of the financed vehicle; you’ve simply guaranteed the loan in which the car serves to “secure” the loan.
Since the cosigned car loan is collateralized, none of your personal property can be seized to pay the debt. Though you may have to sell something to make up for a deficiency and any legal judgments, the lender “can’t just swap other assets you own for collateral,” says Weaver.
If the borrower files for bankruptcy, you’ll be solely responsible for the remaining debt obligation of the car loan. Though the borrower’s credit would be impacted by their bankruptcy, yours would remain unchanged so long as you continued to pay down the loan.
Similarly, if you file for bankruptcy as the cosigner of an auto loan, you would leave the borrower as the sole party responsible for paying the debt. This time, your credit would take a ding from the bankruptcy, but you’d no longer be responsible for the loan, nor would you continue to be listed as its cosigner.
The Servicemembers Civil Relief Act, or SCRA, provides protection to borrowers and cosigners engaged in active military service, so long as a down payment or at least one monthly payment was made on the loan before entering service.
Though the SCRA doesn’t prevent lenders from repossessing a vehicle, it restricts their ability to do so. If either you or the borrower are protected by the SCRA, the finance company or dealership must get a court order before repossessing the car.
Before allowing the finance company or dealership to repossess the car, the court may require:
- All or part of the loan payments to be returned to you
- Suspension of the repossession proceedings until you return from service
- An equity payment, or a payment from the lender to you for the difference between the car’s value and the loan’s balance
The SCRA also provides you with recourse if the lender violates the law, allowing you to sue for damages and legal fees, as well as setting aside any judgments made against you.
Can I Be Removed From a Car Loan I’ve Cosigned?
Other than declaring bankruptcy (and not by simply yelling it, Michael Scott), cosigners can be released from a car loan by paying off the loan in full, signing a cosigner release form, being a victim of fraud, or through loan refinancing.
1. Pay off the loan
Letting a loan default or a car get repossessed can wreak havoc on the credit reports of both yourself and the primary borrower. In some cases, it’s best to try and move mountains to pay off the loan as quickly as possible.
In lieu of dipping into your savings, you could try to convince the borrower to sell the car, particularly if it’s worth more than the outstanding loan balance.
Selling the car to pay off the loan could cause a minor inconvenience to the car-less driver, but is much easier to deal with than bad credit caused by a defaulted loan.
2. Cosigner release form
A cosigner release form is exactly what it says on the tin: frees you from your role as a cosigner to a car loan.
“A cosigner release is a legal document that the primary borrower and lender have to sign releasing the cosigner from the obligations of the loan,” explains Blair.
In other words, the primary borrower has to both agree to release you from the loan and “demonstrate that they have the credit and history to handle payments on their own” in a way that satisfies the lender’s requirements, according to Blair.
Cosigner release options may also be exercised after the borrower has made enough monthly payments as specified by the loan contract.
No, committing fraud is not a valid means of getting out from a loan you’ve cosigned for. Rather, if you’re the victim of fraud and were “somehow intentionally deceived into signing the agreement based on material misrepresentations,” says Blair, you should “be able to rescind the cosign agreement the same way someone could rescind a fraudulent contract.”
If the borrower lied about or falsified their income, employment history, or residency when filling out the initial loan application, they’ve committed lending fraud. Cosigning such a loan can leave you responsible when the borrower inevitably runs into trouble paying for a loan they’d never qualify for without lying, if they even intended on paying their debt in the first place.
Because you must report the fraud before your name’s removed from the loan, the borrower is likely to find themselves in legal hot water. Reporting their crime can throw a wrench into your relationship with the borrower.
Unfortunately, failing to have yourself removed as a cosigner to a fraudulently-acquired loan could be seen as you accepting your responsibilities, potentially leaving you on the hook for the debt.
4. Car loan refinancing
Creditworthiness fluctuates throughout life, and particularly as you age and practice good credit habits. Refinancing a loan is often a good idea if a borrower’s credit has significantly improved since they first applied for auto financing.
It’s also an effective means of releasing you as a cosigner. “If the primary borrower can demonstrate the financial ability to handle the loan without help, or is able to substitute a new cosigner,” says Blair, they may be able to qualify for refinancing.
Refinancing would take into account the borrower’s current credit score and history, including payment history, which accounts for 35% of a FICO credit score.
If the borrower is approved, all involved parties — the borrower, new cosigner (if applicable), and new finance company — would have to agree to the terms of the new loan.
However, provided the borrower has been responsible and hasn’t missed any monthly payments, he or she would likely qualify for better terms, including a lower interest rate.
Unfortunately, you can’t refinance the loan on your own. Simply put, the loan isn’t yours, but there’s nothing stopping you from recommending that the borrower looks into refinancing, particularly if you express your desire to be removed as the cosigner.
Know and Exercise Your Cosigner Rights
Cosigning a loan is like a gift for someone whose bad credit or lacking credit history otherwise prevents them from qualifying. Many times, too, your decision to cosign can kickstart the credit history of a family member, loved one, or friend.
But your decision to cosign shouldn’t come at the cost of your own creditworthiness.
Before signing on the dotted line, carefully consider the potential downsides of becoming a cosigner. If you still decide to dot all the i’s and cross all the t’s, make sure you’re familiar with your cosigner rights. You won’t need to exercise them in a best-case scenario, but don’t compromise your own credit for someone else’s blunders (willful or not).