When someone applies for a car loan in Canada and receives unfavourable loan terms or even a loan rejection, that isn’t the end of their dreams of owning a quality vehicle. They can always turn to a co-signer to help secure the loan or get better terms.
But there can sometimes be a lack of clarity around co-signing, as well as the responsibilities involved. Below, we cover the ins and outs of being a co-signer and the pros and cons of co-signing for an auto loan.
What Is a Co-Signer?
A co-signer is a person who signs onto a car loan with the main borrower. Generally, this person has a strong credit score or financial situation and is essentially vouching for the borrower. In return, the co-signer is also taking equal financial responsibility for repaying the full amount of the car loan.
A co-signer can be virtually anyone with a better financial situation or credit history than the borrower, but it’s typically with a family member, a close friend, or a significant other.
Why Would Someone Need a Co-Signer for a Vehicle?
There are several situations where a borrower may need a co-signer to help them get approved for a loan, or even just to improve their loan terms. They are as follows.
Bad Credit
Lenders will partially base their loan approval and interest rate on the borrower’s creditworthiness. When someone has bad credit, or some flaws on their credit report, lenders may increase the interest rate on the loan, driving the payment very high, or reject the credit application altogether. Some banks may offer to approve the loan but will require a down payment that the borrower can’t afford.
With a co-signer who has a good credit score, the lender may be more willing to approve the application, attach a lower interest rate to the car loan, or accept a lower down payment.
No Credit
When it’s a borrower's first time using credit or it’s been a long time since they have used credit, their credit report may have no information on it and they may not have a credit score at all. Unfortunately, having no credit can be just as bad as having bad credit to some lenders, meaning they could be rejected for a car loan or receive a very high interest rate.
With a good-credit co-signer, someone with no credit may get approved for a car loan with more favourable loan terms. For example, a student looking for a car loan who was initially denied due to his nonexistent credit history but was eventually approved after his aunt with a strong credit score agreed to co-sign for him.
Unfavourable Financial Situation
The borrower’s financial situation could also lead to a need for a co-signer. For example, if the borrower has a high debt-to-income ratio (DTI ratio), the co-signer’s finances can help lower the DTI and help get the loan approved.
Another situation is an irregular paycheque. Someone who works for tips or commission, for example, may earn plenty of money to afford the car payment, but can’t show the income consistency the bank wants. This can also apply to someone who has just started working and has a limited income history to show the bank.
What’s the Difference Between a Co-Signer and Co-Buyer?
On an auto loan application, you will see areas for both a co-signer and a co-buyer and may be wondering what the difference is.
The two categories are similar in that both share equal financial responsibility for the loan with the main borrower. The key difference, however, is that the co-signer has no ownership rights to the vehicle, so they won’t be on the title or registration. A co-signer is simply a guarantor for the lender.
On the other hand, a co-buyer has equal ownership rights with the primary borrower.
What Are the Benefits of Being a Co-Signer?
There are a few benefits to being a co-signer on a car loan, and they are as follows.
Helping a Friend or Family Member
First and foremost, you're helping a loved one secure the vehicle they need. Plus, you’re helping them get a car loan, which can establish credit if they have none and help them build credit — or rebuild it if they have bad credit.
Build Your Credit Score
As a car loan co-signer, the loan and its monthly payments will also appear on your credit report. As the borrower makes on-time payments, you may also see these payments positively impact your credit score.
What Are the Risks of Co-Signing?
There are several reasons to think twice about being a co-signer, and they’re as follows.
Immediate Credit Score Impact
When you co-sign for a loan, a few FICO credit score variables may be negatively impacted by it. These include:
- Amounts owed: When you co-sign for an auto loan, you take on responsibility just as the borrower would, which means the loan will show on your credit report and increase the amount you owe in installment debt. The amount owed variable accounts for 30% of your FICO score, so you could see a noticeable dip in your credit score once the lender reports the loan to the credit bureau.
- Length of credit history: When the new car loan shows on your credit report, it can shorten the average age of the debts on your credit report. This variable accounts for 15% of your credit score, so you may notice a small decrease.
- New credit: The new credit variable accounts for 10% of your FICO score and is negatively impacted by new loans and hard credit inquiries. These will both show on your credit report when co-signing for a loan, potentially decreasing your credit score.
Difficulty Qualifying for a Loan
When you co-sign for a loan, it can also negatively impact your DTI, which can make securing a personal loan, private student loan, car loan, mortgage loan, credit card, or any other type of debt. As the borrower pays off the debt, this negative impact may lessen.
Potential for Big Credit Score Impacts in the Future
If the borrower lands in a tight situation and can’t make the car payment on time, has missed payments, and/or runs 30 days late, you’ll get the same 30-day late payment negative mark on your credit report as the borrower. And it only gets worse if the borrower falls further behind on their loan payments.
If the borrower defaults on the loan and the lender repossesses the vehicle and places the account in collections, those will also appear on your credit report. This can cause significant damage to your credit score.
You Could Be Sued
If the borrower defaults on the loan and the lender seeks judgment on the debt, the courts could rule in the creditor’s favour and garnish your wages or your bank account for the loan amount.
Financing With Clutch May Not Require a Co-Signer
Clutch, Canada’s largest online used car retailer, has a wide range of quality pre-owned cars to select from and get delivered to your door. Not only is our process convenient and stress-free, but we can also handle financing 100% online. Even with imperfect credit, you may not need a co-signer.
To find out if you need a co-signer, fill out our online credit application. Our finance team will review your loan application and submit it to our lenders. We can always add a co-signer to your application if you need one to get approved or to get better loan terms. Plus, our credit application doesn’t impact your credit score, so there’s no risk to find out if you need a co-signer.
Speaking of no-risk, all Clutch vehicles go through a 210-point inspection and reconditioning process and include a 90-day warranty. They also include a 10-day test-own period, so if you don’t love your new Clutch vehicle during this time, you can return it for a refund or exchange it with no questions asked.
Check out our vast inventory of pre-owned cars in Canada and find your dream car today.
