How to protect yourself when co-signing a car loan
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Signing off as a co-signer can make vehicle ownership possible for a friend or family member who may not qualify for financing without your help. But co-signing comes with risk — since you share equal legal responsibility for the loan, missed payments or default will affect your finances. But if the vehicle owner is responsible, co-signing could actually improve your credit.
5 ways to protect yourself as a co-signer
Consider these factors to safeguard your financial security if you decide to act as a co-signer on a future auto loan.
1. Serve as a co-signer only for close friends or relatives
A big risk that comes with acting as a loan co-signer is potential damage to your credit score. Ideally, you should only assist a friend or family member who you trust — someone with a consistent income who is financially stable. You need to be confident that the primary borrower will be able to pay but just didn’t qualify due to their lack of financial history or age.
2. Make sure your name is on the vehicle title
Co-signers do not hold ownership of the vehicle. This means the way you are named on the loan agreement matters. If you are not named on the title, you may not have a legal claim on the vehicle but would be on the hook for potential payments. Confirm that the title states the primary owner and yourself. This way the vehicle cannot be sold without both parties’ signatures.
3. Create a contract
Although you will both sign off on the loan itself, having a separate contract stating your expectations for the primary borrower can be an added layer of protection and serve as a reminder of the agreement’s severity. This contract doesn’t have to be too complicated. Just a promissory note outlining the costs, obligations and what default will mean for both parties. After you both have agreed, bring it to a notary to have it finalized.
4. Track monthly payments
One way to feel more confident in the primary borrower’s ability to pay is to keep track of the monthly payment schedule. This could be as simple as setting a calendar reminder to check on their spending. While this might feel awkward, remember that your credit is on the line. Simply reach out and open up a conversation to check in on your friend or family member without micromanaging the loan.
5. Ensure you can afford payments
When all else fails, you need to know that you can cover the payments on the loan. If you are not able to pay back the lender, your credit score will be in trouble — and you may risk default and other legal action. The primary borrower has the majority of the responsibility, but you are ultimately on the hook for the loan as a co-signer.
How co-signing an auto loan affects your credit
The risks of co-signing a car loan are simple though potentially severe. If the person you co-sign for doesn’t pay, your credit could take a big hit and you’ll be on the hook for paying the loan. But there are also potential benefits to your credit score:
- Credit mix: Depending on your current open credit accounts, adding a car loan to your credit report could potentially improve what’s referred to as your credit mix. Your credit mix makes up 10 percent of your FICO credit score.
- Payment history: Just as your score could decrease if the primary borrower doesn’t make timely payments, it’s possible to benefit — though on a much smaller scale — from them making consistent on-time payments.
The bottom line
Acting as a co-signer is a big financial decision and could lead to interpersonal or financial headaches. But for many, it makes the difference between having a vehicle or not. So if you decide to be a co-signer, protect yourself and be sure you can afford to pay the loan in case the primary borrower defaults.