Who needs a co-signer for a car loan? How does it work?
New or first-time car buyers are often surprised at being turned down for a car loan because they have no credit history, which unfortunately has about the same effect as having bad credit. Getting a co-signer might be the answer.
Lenders want to see that a borrower has a good record with previous loans and credit cards. Without a history of credit, a borrower represents a risk to lenders. If they don’t know a borrower’s history, they take the low road and assume the worst.
It’s a familiar “catch-22″ situation in that you can’t get a loan to establish credit without already having credit. So what is the answer?
What is the answer?
The most common solution is to have someone “co-sign” your loan contract. Typically, it’s family member who has a good credit score. A co-signer plays no part in the loan unless the primary borrower fails to make payments. In that case, the loan company would have the right to seek payment from the co-signer.
A co-signer does not share ownership of your vehicle. If you pay off your loan on time and without problems, the co-signer has no further role, rights, or responsiblities. Their job is finished.
Even if you default (fail to pay) on your loan and the co-signer has to step in and make payments, he/she still has no owership rights. The car would still be in your name. Many people who co-sign do not understand this important point.
Another point that is important for co-signers to understand is that a co-signed loan or lease shows up on both the borrower’s credit report and the co-signer’s as a financial obligation or debt. This may affect the co-signer’s ability to get a new loan or lease for themselves if they are already close to being over-borrowed. It increases their “debt load” which is a factor that is considered when one applies for new credit. Both you and your co-signer should know your credit score before you apply for a car loan. There are actually 3 credit bureaus that report your credit. You can see all 3 bureau reports and 3 scores with a $1 seven-day trial instantly online with a simple enrollment in CreditReport.com, which shows your score instantly.
However, on the postive side, if you pay off your loan with no problems, both you and the co-signer benefit from the good credit report. Both you and the co-signer will improve your credit scores. This makes having a co-signer a great way for someone with no credit to begin building a good credit history.
Selecting a co-signer
You should take care in selecting a co-signer. Since approval of your loan will depend on their credit worthiness, the person should have a strong and healthy credit history, a steady source of income, and not have excessive debt. For most new car buyers, this will probably be a close family member.
If you have already shown a history of financial irresponsibility, you may have difficulty finding someone who is willing to assume responsibility for your new obligations. Like the banks or loan companies, your potential co-signers may not want to take on the added responsibility and credit debt load. If the co-signer is not able to take over payment when the primary borrower defaults, both the borrower’s and the co-signer’s credit score are damaged.
Warning about co-signers
Anyone who is going to use a co-signer for their auto loan is usually listed as “primary” on the loan and the co-signer is “scondary.” The primary signer is the one buying the car and who will own the car when the loan has been paid off. But here’s something to watch out for: If the person buying the car doesn’t have sufficient income to make payments, or has excessive debt, a dealer may switch primary and secondary signers on the loan contract, and “forget” to mention it. This means the person who thinks they’re buying the car could possibly end up being the co-signer, and the person who thought they were co-signing becomes the primary buyer of the car, regardless of who actually makes the payments. Watch out for this situation before you sign your contract. Otherwise, it’ll be too late to change it or cancel the deal.
If you can’t find a co-signer
If you can’t find someone who will co-sign for you, you have few other options. You may have to work out your transportation needs another way while you save enough money to get started with an inexpensive used car, while building your credit history so that you won’t need a co-signer the next time. Get a couple of credit cards or department store cards, use them often, and pay them off each month. You can then monitor your credit score with a service such as CreditReport.com
You could also borrow cash from friends or family, although this method doesnhelp you build a good credit history. In many cases, you may not need the entire amount to buy your car. Often, a large down payment will allow you get a loan even with no credit or bad credit. A smaller loan presents less risk to a lender, and could allow you to be approved.
You could also try a used car dealer who specializes in working with people with bad credit, known as “buy here pay here” dealers who finance their own loans, which means it won’t help — or hurt — your credit. Just know that this kind of dealer usually sells overpriced vehicles at very high loan interest rates.
Getting a co-signer is a great way to start building your own credit history. If you make your payments on time, don’t skip payments, and don’t default on your loan, you’ll be in great shape for your next loan — without a co-signer.