How Cosigning Auto Loans Impacts Your Credit if Not Repaid


How Cosigning Auto Loans Impacts Your Credit if Not Repaid

Cosigning an auto loan for someone can seem like a great way to help out a friend or family member who needs a car but can’t get approved for financing on their own. However, being a cosigner comes with some big risks that you need to seriously think about before signing on the dotted line. If the primary borrower stops making payments or defaults on the loan, it can majorly damage your credit and finances too.

In this article, we’ll break down everything you need to know about how cosigning an auto loan works, the pros and cons, and what happens if the loan goes unpaid. I’ll be real with you – there’s a good chance cosigning could come back to bite you. But if you go in with eyes wide open, set clear ground rules with the primary borrower, and take steps to protect yourself, you might decide the risk is worth it to help out someone in need. Let’s dive in!

What Exactly Does It Mean to Cosign an Auto Loan?

When you cosign an auto loan, you and the primary borrower are agreeing to be jointly and severally liable for the debt. That means the lender can pursue either of you for the full amount owed if payments aren’t made on time each month.

Basically, you’re putting your good credit on the line to help the other person get approved for the loan or get a lower interest rate. The lender looks at factors like your income, credit score, and debt-to-income ratio when deciding whether to approve the application and what terms to offer.

If the primary borrower defaults, the lender can repossess the car and come after you for the remaining balance. They can also report late payments to the credit bureaus, damaging both your credit.

The Main Pros of Cosigning an Auto Loan

Okay, so why would anyone agree to put themselves in this position? There are a few potential upsides of cosigning an auto loan when done carefully:

  • It can help out a family member or friend in need of a car. If someone you care about has bad credit or no credit history, adding you as a cosigner may allow them to get approved and find reliable transportation to work or school.
  • The primary borrower can build their credit. As long as they make the payments on time each month, the loan will help establish their credit history. After 1-2 years of on-time payments, they may be able to refinance the loan without a cosigner and take over the loan themselves.
  • You may be able to get a lower interest rate together. Especially if the primary borrower has little credit history, adding your good credit to the application often results in a lower rate compared to what they could get on their own. This makes the loan more affordable.
  • It can strengthen your relationship. Cosigning an auto loan for a younger family member like a sibling or child can show you care about their well-being and future financial success. It demonstrates faith in their ability to handle the responsibility.

The Potential Downsides and Risks of Cosigning

Now let’s talk about the biggest reasons to think twice before cosigning an auto loan. There are a lot of ways this decision can negatively impact you if things don’t go according to plan:

  • You’re 100% on the hook for the loan if payments aren’t made. If the primary borrower stops paying, you’ll have to cover the monthly payment to avoid hurting your credit. If they default altogether, you could be forced to repay the loan in full immediately. This can destroy your finances if it’s a large balance.
  • Your credit can suffer. If the loan becomes delinquent, it damages both your credit history. Late payments get reported to the credit bureaus and can significantly drop your credit score. A default can stay on your credit report for up to 7 years.
  • It raises your debt-to-income ratio. Even if payments are made on time, the cosigned loan still counts toward your DTI since you’re legally obligated for the debt. This makes it harder for you to qualify for any future loans or credit cards.
  • Your relationship may sour. If you end up stuck making payments or the loan goes into default, it often causes bad blood between family members or friends. The borrower may struggle to pay you back or even avoid you altogether.
  • Future lenders may view you as higher risk. Having a previous cosigned loan on your credit report could make lenders see you as a riskier borrower in the future, even if the loan was paid off. They know you’re willing to take on debt for others.
  • It could impact your ability to get a mortgage. Most mortgage lenders require detailed documentation on any cosigned loans, even if you’ve been timely on payments. Too much cosigned debt could derail your chances of getting approved for a home loan.

What Happens if the Cosigned Auto Loan Goes Unpaid?

Now let’s get into the nitty gritty of what happens if the primary borrower stops making payments on a cosigned auto loan. There are a few different scenarios:

The loan becomes delinquent – If the primary borrower only makes partial or late payments, the loan will become increasingly delinquent. Once it’s 30 days past due, it will start getting reported to the credit bureaus and negatively impact both your credit scores.

The car is repossessed – If too many payments are missed, the lender can repossess the vehicle. But this doesn’t get either of you off the hook – you are both still on the line for repaying the remaining loan balance.

The loan goes into default – After several months of nonpayment, lenders will usually declare the loan in default. At this point, they can demand full and immediate repayment of the outstanding balance. If it’s not paid, they can sue both you and the primary borrower.

Debt collectors come calling – Collection agencies will start contacting both you and the primary borrower demanding payment on the defaulted loan. This means frequent calls at all hours plus derogatory marks on your credit reports.

You’re forced to repay the loan – As the cosigner, there’s a very good chance you’ll have to repay some or all of the loan amount even if you weren’t the one driving the car. The lender can garnish your wages, put liens on your property, or sue you in court for the money.

Bankruptcy – As a last resort, the primary borrower may file for bankruptcy if they’re totally unable to repay the auto loan. This can provide them relief from the debt, but typically does NOT release you from liability as the cosigner. You’ll still be on the hook.

5 Tips to Protect Yourself When Cosigning an Auto Loan

If you decide to cosign an auto loan after weighing the risks, here are some smart tips to help protect yourself:

  • Ask the primary borrower to make you an authorized user on the loan. This ensures the payment history also gets reported to your credit report, even if you’re not making the payments yourself.
  • Set up automatic payments from the primary borrower’s bank account so payments are never late. Make sure they have overdraft protection too.
  • Create a written agreement detailing the repayment terms and what happens if they default. Have it notarized.
  • Only cosign an amount you can comfortably afford to repay yourself in a worst case scenario. Don’t overextend.
  • Monitor the loan status regularly and stay in touch with the primary borrower. Act quickly at the first sign of trouble.

The Bottom Line – Think Carefully Before Cosigning

Cosigning an auto loan for someone with bad credit or no credit history can seem like a kind and generous thing to do. But it comes with serious risks that can wreak havoc on your finances and credit if the borrower fails to uphold their end of the deal. Make sure you fully understand the legal implications, create safeguards, and are prepared for the worst before signing on the dotted line.

Proceed with extreme caution – or consider recommending the borrower explore secured credit cards or credit-builder loans first to establish their own payment history. Cosigning an auto loan is one of the biggest financial favors you can do for someone. Be sure you can afford the cost if things go south.

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