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If a loved one has asked you to co-sign a car loan, you might be in a tough spot. On one hand, you want to help your close friend or family member. But on the other hand, you’d be putting your own financial future on the line.
If a loved one has less-than-perfect credit, they may have trouble getting approved for a car loan. Or if they can get approved, the interest rate might be in the double digits. Getting a co-signer with solid credit can help increase their odds of approval and possibly secure a lower rate.
Before you jump in to help your friend, it’s important to understand exactly what co-signing a car loan means, including what you’ll be responsible for and what potential effect it could have on your finances.
What is co-signing for a car?
A lender or leasing company may require an applicant to have a co-signer if the applicant’s credit and income don’t meet the lender’s requirements to be approved on their own. Typically, the co-signer will need strong credit. If you choose to co-sign for a car loan, your name — along with the applicant — goes on the loan documents, and you become legally responsible to pay back the loan, even though you have no right to the car itself.
If your loved one misses a car payment or defaults on the loan, those delinquencies can show up on your own credit history. And if your family member or friend defaults, you’ll be liable for repaying what’s owed, along with any late fees or collection costs. In a worst-case scenario, the lender could sue you or garnish your wages to collect the money.Sometimes co-signing for a car might go bad. Learn more.
In some cases, you might be able to negotiate exactly what you’re responsible for as the co-signer before you sign the loan, according to the Federal Trade Commission. For example, if you only want to be on the hook for repaying the loan principal, and the lender agrees, you could ask the lender to include those terms in the loan contract. Again, this negotiation would have to happen before you sign on the dotted line.
How does co-signing for a car affect your credit?
When you co-sign a loan, the loan can show up on your credit reports. If your friend or family member doesn’t make a payment on time or at all, that can also show up on your credit reports, and could negatively affect your credit scores.
This could also affect your ability to get approved for a loan of your own down the road. With the responsibility of the applicant’s loan on your shoulders, your debt-to-income ratio, or DTI, can increase. Your DTI is a key factor that many lenders consider when reviewing a loan application. Even if you’re able to secure a loan with a co-signed loan on your credit history, you might face less favorable terms.
Before you co-sign for a car …
The risks of co-signing for a car can be big. Here are some things to consider before you take the plunge.
Can you afford the payments?
In the worst-case scenario — if the person you co-signed a loan for can no longer afford the loan and ends up defaulting — could you afford to take over the monthly payments? Depending on the size of the loan and the loan term, you could end up responsible for a hefty amount of money. If your budget can’t cover these costs, saying yes to co-signing could put your finances at serious risk.
Do you want to take on a long-term financial commitment?
You’ll be responsible for repaying the loan throughout its entire term if your loved one defaults — unless the person you co-signed the loan for refinances the car loan. This might give the original applicant the option to remove the co-signer from the loan. If they improve their credit by making on-time payments and paying down their debt, they might be able to refinance their car loan in the future. At that point, they might be able to remove you as the co-signer by refinancing the new loan in their name only.
Are you willing to check in on the loan each month?
Since any missed or late payments can affect your credit, checking in each month to make sure your friend or family member will be making their loan payment is a good idea. Lenders are under no obligation to notify you if a payment was missed — though you could ask the lender to let you know when your friend misses a payment.
How strong is your relationship with the person asking you to co-sign?
Checking in regularly on your friend or family member to make sure they’re making payments — or having to cover a missed payment — could put some strain on your relationship. Consider whether you think your relationship could remain intact with this added financial pressure.
In the end, you’re 100% responsible for the entire loan amount in the case of default when you co-sign for a car. And you’re risking not only your finances but also your relationship with your friend or family member.
If you decide not to co-sign, explain why. You might also offer to help your friend in other ways. For example, you could help them search for a less-expensive car that would require a smaller loan. Or you might loan them some money for a down payment to help improve their loan approval odds. Both options could help your friend get a set of wheels without you taking on credit risk.