How Does a CoSigner on a Car Loan Work?

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When an individual does not have the qualifications to secure a car loan they can use a cosigner. This person agrees to pay the debt if the borrower defaults on the loan. The cosigner must have a long credit history and a decent credit score. This often enables the borrower to secure the loan at a much better rate. There are some excellent reasons for a cosigner to agree to sign the auto loan.

Helping the Applicant

Most people require a loan to be able to purchase a new car. When they are unable to secure a loan this can easily prevent them from purchasing a new car. When a borrower is rejected for a loan or any type of credit it is usually because they have a low credit score or a poor credit history. Different lenders, bad credit loans and creditors are often willing to reconsider issuing the loan if it is also signed by a cosigner. When the cosigner agrees they are providing the opportunity to help the borrower obtain transportation to travel to and from work, attend school or simply have reliable transportation.

Building Credit

In order to build a credit history or improve a credit score, the individuals must first obtain credit, even if this is via hard money loans. This can be extremely challenging because the borrower does not have the qualifications to obtain credit. When a cosigner signs a loan they are helping the borrower establish or build their credit history and credit score. This will make it easier for the borrower to obtain another loan in the future without assistance.

The Debt to Income Ratio

Prior to cosigning a loan, the individual must understand the implications. When a person becomes a cosigner they increase their debt to income ratio. This is determined by dividing the individuals total debt by the income they earn each month. If the cosigner earns $10,000 per month and their monthly debt totals $7,500 their debt to income ratio would e 75 percent. A cosigner must sign all loan documents and attend the closing of the loan. In addition to the debt being added to the cosigners debt to income ratio, the loan will be a part of their credit report. If the borrower defaults on the loan it is the cosigners responsibility to make the payments. The maximum amount recommended for a debt to income ratio is 36 percent. If this figure is higher it often lowers the individual’s credit score. The FICO score of any individual is thirty percent of the amount of debt they owe. This is influenced by all debt from traditional lenders to hard money loans.

The Permanence of a Cosigner

Once an individual cosigns a loan they are responsible for the loan until the last payment has been made. The cosigners name cannot be removed from the loan. There are only two exceptions. The first is a cosigner release clause. This clause states if the borrower makes the car payments on time for a specified period the name of the cosigner can be removed from the loan. This type of clause is used mainly for student loans but can be requested for any loan from any lender. The second is if the borrower successfully refinances the loan by themselves.

The Credit

Many people cosign loans for friends, family or a loved one. They must be aware of the reason the individual is unable to secure a loan or they haven’t thought about bad credit loans. This may be a child who is just starting out and has not built a credit history yet. This could also be a person who has a poor history due to paying their bills late or has already defaulted on a loan. If the reason is the latter the cosigner must understand they are taking a risk. Their credit score may be damaged and they may have to make the payments.

When to Cosign a Loan

Cosigning a loan is a personal decision. There is always a risk but often the reasons to sign are more important than the risk. Many parents will cosign a car loan for a child attending college or just leaving home. Sometimes the borrower has made mistakes in the past and is looking for help in starting over. The potential cosigner must consider all the risks prior to signing the loan. They must understand they may be damaging their credit if the borrower misses a few payments. The most important questions a potential cosigner must ask of themselves is if they believe the borrower will make all the payments on time, if they are willing to take the risk if the borrower misses payments and if they are willing to risk their credit score and history for this individual.