The decision to cosign for a loan is not to be taken lightly. Like many other financial decisions, cosigning for a friend or family member’s loan can affect your credit and your financial well-being for years to come. If you approach cosigning from a purely self-interested standpoint, it is almost never appropriate to sacrifice your own credit and security to help someone else buy a car. On the other hand, there are a few intangible reasons that might still motivate some people to be cosigners.
What is Cosigning, and why is it Necessary?
Banks, by their very design, are risk-adverse. When a bank gets a loan application from someone with less-than-perfect or perhaps non-existent credit history, the bank doesn’t know whether this person is going to be able to pay the loan back. Cosigners are additional people, usually with great credit, that can be made “also” responsible for the loan, reducing the total risk to the bank by ensuring that a second individual will make payments if the first individual defaults.
What this means for the cosigner is clear: Cosigning for a loan can place you in the position of being responsible for that loan’s payments. In the event that the primary signer of the loan defaults or misses a payment, you will be held personally responsible for making up the balance. Despite this responsibility, the property that the loan was for (a car, for example) remains the property of the original signer.
Pros and Cons of Cosigning an Auto Loan
Cosigning is obviously a good thing for the original borrower, as it helps them secure a loan at a better interest rate than they would normally be able to afford. Cosigning is also good for the banks, helping them mitigate the risk of lending to new borrowers.
Unfortunately, cosigning isn’t so great for the cosigner. Cosigning can cause financial hardship in the event that the original borrower defaults, adding an additional loan payment that the cosigner didn’t plan for or anticipate. Cosigning can also hurt a cosigner’s credit if the borrower misses payments, and it can strain relationships in the event of a default.
Should You Cosign for a Loan?
The answer to this question is, almost always, no. Cosigning is not a good idea when approached from a purely self-interested standpoint, as it provides no tangible benefit for the cosigner. On the other hand, if a close family member, someone that you truly trust, is attempting to buy a car, cosigning can be a good way to signal your trust and compassion. Just make sure that the borrower is choosing a car loan that they will be able to afford, and encourage them to apply for loans without a cosigner just to see if banks will be willing to give them the loans anyways.