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When someone applies for a car loan, lenders check their credit score and credit history to determine if they're a safe borrower. If they have a limited credit history or low score, a lender may deny the loan application or charge sky-high interest rates to make up for the risk. If your credit is good, vouching for the borrower by cosigning can help them secure a loan that's otherwise out of reach.
But when you cosign a loan, you're not only helping the borrower qualify, you're also taking on the same risk they are. Because the lender owns the vehicle until the loan is fully paid off, it can repossess the vehicle if the borrower is unable to make payments. Repossession and the missed payments leading up to it can negatively impact the borrower's credit—and that of the cosigner—for up to seven years.
Repossessions can happen when payments on a car loan are missed and communication attempts from the lender go ignored. In most states, lenders don't have to warn you that they are repossessing the car and can simply send a tow truck to collect the vehicle.
Once a vehicle has been repossessed, the lender will sell the car to make back the amount they loaned. If the car sells for less than what's owed on the loan, they may require payment of the difference, which is known as a "deficiency balance."
How Can Repossession Affect Your Credit as a Cosigner?
As a cosigner, you use your good credit score and history to help the primary applicant, usually a relative or close friend, qualify for a loan. The lender approves the loan based on your qualifications, under the assumption that if the applicant doesn't make their payments, you will make good on the obligation. Even though you don't own or use the car, you and the primary borrower are equally responsible for making sure the loan gets paid.
If the person for whom you've cosigned falls behind on their payments and their car is repossessed, the repossession will hurt your credit just as it hurts theirs. The repossession will be listed on your credit report for seven years from the date of the first missed payment that led to the repossession. You could also be held liable for the deficiency balance, along with any repossession costs and fees.
But the hits to your credit start well before the car is repossessed. Your credit report will show a history of late payments on the loan, as well as the loan going into default. If you or the primary borrower do not pay the deficiency balance and the lender sends it to collections, the collections record will also appear in your file. Finally, any court judgments associated with the loan will go on the credit histories belonging to both loan signatories.
Even if you have great credit otherwise and make all of your own payments on time, a repossession or default on a loan you cosigned could seriously hurt your credit score.
What to Ask Before You Cosign
Before you agree to cosign a loan for someone, you may want to have an open discussion about their finances. It can be difficult to discuss money with friends and family, but it's important to remember that you're taking on the responsibility of a loan as the cosigner.
Your credit is on the line as much as your loved one's, so it's a good idea to fully understand their debt history and ability to make their car payments before you make a decision.
Here are some questions that may help you start the conversation:
- Why weren't you able to qualify for the loan on your own?
- Have you ever been late on payments in the past, including other loans or credit cards?
- Are you able to pay your monthly bills without using credit or borrowing from friends and relatives right now?
- How much will the monthly car payments be?
- Do you have a budget you can share showing how you will afford the payments?
You may find that the person couldn't qualify on their own because they have a limited credit history and needed someone with a stronger record of good credit management and on-time payments to strengthen their application. On the other hand, perhaps a friend has a few bad credit marks from a few years ago pulling down their score. They've since gotten better at managing their money and debts, but those marks still may be cause for concern.
Whatever the reason, having context about their finances can help you make an informed decision about whether to cosign the loan. Ultimately, it's your decision to make based on what you know and what you might be able to find out if you ask.
If you choose to cosign, it could help to come up with a game plan with the borrower for what to do if they can't make their payments for a couple of months. Decide how you'll communicate about potential problems and at what point you'll step in to help with payments.
Agreeing on how you'll communicate about the loan is important because the lender will only send bills to the primary borrower. The lender doesn't have to inform cosigners that payments are late or that the loan is in default. Consider talking to the primary borrower about whether they'll show you their monthly statements or provide account access so you can monitor the loan's activity.
You may want to keep a few months of payments in a savings account in case you need to help out with the loan for a little while. Ideally, the primary borrower will manage the payments for the entire life of the loan. But knowing that you have the money to keep the account in good standing in a worst case scenario may bring you peace of mind.
What Rights Do Cosigners Have in Auto Repossession?
If a lender repossesses a car, will contact you regarding your options for the vehicle. These might include:
- Reinstating the loan: You may be able to bring the account current by paying all past-due amounts and fees.
- Redemption of the vehicle: You can buy back the car by paying off the balance plus fees.
Assuming that you choose not to reinstate the loan or buy back the car, the lender will also let you know when and where the car is being sold and how they will calculate the deficiency balance.
Federal law requires lenders to conduct a "commercially reasonable" sale, which means they cannot sell the car for significantly less than the fair market value and then require you to pay the difference.
How to Rebuild Your Credit After Repossession
Although a repossession stays on your credit report for seven years, there are steps you can take to repair your score.
- Make sure all other accounts are paid on time. Payment history is the biggest factor influencing your credit scores, so set up a plan for ensuring that no other accounts are paid late. You may want to set up automatic payments with any lenders that offer it to make account management easier.
- Catch up on late payments and charge-offs. If you're behind on any other bills or have accounts that are currently in collections, it can help to pay those off as quickly as possible. The goal is to keep all of your open credit cards or loans in good standing, and avoid their being sent to collections.
- Monitor your credit report. Keeping a close eye on your credit report will help you identify risk factors such as high credit card debt and missed payments. Once you better understand what's in your credit, you're in a better position to take action to improve it. You can request a free copy of your credit report from the three credit bureaus (Experian, TransUnion and Equifax) through AnnualCreditReport.com. You can also get your free credit report and scores directly through Experian as well.
You can also enroll in Experian Boost®ø, which adds certain utility, telecom and other bill payments to your credit report. Their presence on your report means they can factor into credit scores based on your Experian credit file, which may give you a lift.
Just because you have a repossession on your file doesn't mean you have to wait seven years to improve your account. By being proactive and managing your accounts well, you can come back from default, perhaps even sooner than you think.
