For people with unscorable or subprime credit, it can be hard to get a car loan. One of the most common ways that Americans solve this problem is by getting a friend or family member to act as a co-signer on a car loan.
Before you agree to help, know that there are risks!
According to the Federal Trade Commission, a co-signer agrees to guarantee the debt if the borrower doesn’t pay. This may also include late fees or collections’ fees. Depending on the laws in your state, the lender can collect from you without first trying to collect from the borrower if payments are missed. Collections can mean that you could be sued for the debt or have your wages garnished. If the debt is overdue, it can be reported as part of your credit report.
Despite all of this, 71 percent of consumers establishing first-time credit with an auto loan depend on a co-borrower to get approved.
On top of that, for many Americans, money is the number one cause of stress. In an American Psychological Association study, 31 percent of adults with partners reported money as a huge source of relationship stress.
With that in mind, we have compiled these suggestions to help navigate the car loan co-signing waters with someone you care about, while still staying on speaking terms.
1. Lay ground rules
“I think ground rules from both parties should be laid out before signing the loan. Each party needs to know what each other expects from one another. If you’re the one signing, you need to make it very clear about the huge risk you’re taking and the equally huge favor you’re doing for them.”
— Laura Gonzalez, Marketing Manager at Audi Bellevue
2. Set expectations and discuss specifics
“Co-signing a loan is like you taking out the loan yourself except that you won't be making payments as long as the original borrower keeps up their end of the bargain.
If they default on the loan, your credit takes the hit and you will be expected to pay the loan. It is important that they know they are expected to make every payment in full and on time. You are only co-signing to help them get a lower rate or help get them approved.
It's very important to know the terms of the loan you are co-signing. If the borrower cannot make payments, the loan company will go after you to fork up the money. Here's what you should know: total amount borrowed, interest rates, time frame to pay it off, monthly payments, defaulted fees, late fees, early repayment penalties (if any), cosigner insurance, cosigner release benefits, and if the loan can be transferred.
Knowing the terms of the loan can help you when speaking about the loan to your friend or family member. It also lets the borrower know that you know what's going on.”
— Marissa Sanders, Personal Finance Expert, Simple Money Mom
3. Establish trust and open communication
“Each party should have faith in and trust each other for this to go smoothly. If the trust is not there, it could end poorly for your relationship should things go wrong.
Communication is another key aspect of making this work. If it looks like they may not be able to make a full payment on time, they should feel comfortable telling you and you should encourage them to do so. Otherwise, you both will take a hit to your credit.”
4. Make your own personal contract
“If you still decide to help a friend or family member, you should consider how they handle their money.
Although the loan is a contract already, you may want to write a contract between the two individuals about what happens if things aren't paid so there will be no misunderstandings.
Trust will be tested in this kind of situation, so beware of what you get yourself into. Talk about how things would impact your relationship. Remember most people don't talk about their money with others, but if you are going into something together you have a right to know. This discussion can save you some heartache in the future.”
— Damisha Ricks, Author, How to Move Out and Not be Broke!: Young Money Sense
5. Keep lines of communication friendly and open
“Make sure to keep lines of communication open regarding the loan. An occasional, "Hey, how's the loan repayment going?" can keep that line of communication open.
If there is any hardship, you want to make sure this person can come clean to you so that you aren't stuck in the dark.
Make sure to get duplicates of all loan transactions and/or login information so that you are up to date on the loan.
This way, the borrower knows you are well aware of the status and cannot lie about it.”
6. Consider the doomsday scenario
“If someone requires a co-signer for a car loan, it's likely based on their poor credit from failing to fulfill previous financial obligations. You have to consider the very real possibility you'll end up on the hook for this. Before agreeing to co-sign, ask yourself if you're willing to make the payments or accept the damage done to your credit score. Consider how damaging it would be to the personal relationship if it comes to that.”
— Morgan Taylor, CMO and Financial Advisor, LetMeBank
7. It’s okay to say no
“It can be hard to say no sometimes, especially when it comes to family members or close friends. However, it’s okay to say no. You should be thinking carefully and logically about this decision. Ask yourself these questions:
Do they have a history of defaulting on loans?
Do they have a poor credit history?
Do I trust them enough with my credit history?
Saying no can prevent the relationship from going sour. They might be upset initially, but it will work out in the long run.”