What Happens When You Cosign for a Car?
Before cosigning a car loan, understand the significant financial and legal commitment you're making and how to navigate potential outcomes.
Cosigning for a car loan means accepting legal responsibility for the debt if the primary borrower fails to make payments. This arrangement often arises when an individual has a limited credit history, a low income, or a less-than-ideal credit score, making it difficult for them to secure a loan independently. By adding a cosigner with a stronger financial standing, lenders perceive reduced risk, which can lead to loan approval or even more favorable interest rates and terms.
Understanding Your Legal Obligations
When you cosign a car loan, you enter into a binding agreement where you become equally and fully responsible for the debt alongside the primary borrower. If the primary borrower cannot or does not make the required payments, you are legally obligated to repay the entire loan amount. Your name will appear on the loan agreement, signifying your direct liability for the principal, interest, and any associated fees. This responsibility extends to covering late fees and collection costs if the primary borrower defaults. While you are financially responsible, you typically do not gain ownership rights to the vehicle unless you are a co-borrower, which is a different arrangement.
Impact on Your Financial Profile
Cosigning a car loan directly impacts your personal financial standing and credit profile. The loan will appear on your credit report, just as it does on the primary borrower’s report. This inclusion can affect your debt-to-income (DTI) ratio, potentially making it more challenging to qualify for other loans, such as mortgages or additional car loans, in the future. If the primary borrower consistently makes on-time payments, this positive payment history can benefit your credit score. Conversely, any missed or late payments by the primary borrower will negatively affect your credit score, mirroring the impact on their own credit.
Actions a Lender Can Take
Should the primary borrower default on the car loan, the lender can take various steps to recover the outstanding debt. Lenders will typically initiate contact with both the primary borrower and the cosigner through collection calls and demand letters. Delinquencies will be reported to credit bureaus, which will negatively impact the credit scores of both parties. The lender may then proceed with repossessing the vehicle to mitigate their losses. Even after repossession and sale of the vehicle, if the proceeds do not cover the full loan balance, the lender can pursue legal action for the remaining “deficiency balance,” which could lead to wage garnishment if a judgment is obtained.
Options for Cosigner Release
There are potential avenues for a cosigner to be released from their obligation on a car loan, though these are not automatic and often require specific conditions to be met. One common method is for the primary borrower to refinance the loan solely in their name. This involves securing a new loan to pay off the existing one, effectively removing the cosigner from the new agreement. Another option is for the primary borrower to sell the vehicle and use the proceeds to pay off the entire loan balance. In some cases, lenders may offer a cosigner release option after a certain number of on-time payments have been made by the primary borrower, but this is less common and depends on the specific loan agreement.