Friday, June 3, 2011

Is Cosigning A Car Loan Really So Bad?

Janet's 2010 Chevrolet Cobalt in SarasotaImage by roger4336 via FlickrWe all know that cosigning a loan is just asking for trouble. Your taking a big risk that the person you are cosigning for will leave you holding the bag. When the bank doesn't approve an individual for a loan the bank is saying plainly that they believe the person is not financially or personally able to pay it back. Why can't people who are tempted to cosign a loan, for a freind or relative, be as calculating as that?

I have written before about my daughters car problems and need for replacing her car. The car has 210,000 miles on it and it's time. Yet the car continues to live on and won't die. She and her boyfriend have purchased a 2006 Chevy Cobalt. It's in great shape and has low mileage. It was a really great choice.

Then why am I bringing all this up? Well, they have bad credit, when they financed it they got a very high interest rate. It's 18% interest. The payments are high and a lot of money is going to interest. I want to help.

I feel if I refinance the car as a cosigner I could get their rate down to 5%. It would be a big help in getting the payment way down. But then that would go against the no cosigning rule.

If I did do it, would there be a chance they wouldn't pay it. Yes, there always is a they could lose their income and be unable to pay and also by their track record not pay their debts. I would then be on the hook for the note. Is it worth it to take the chance? Would it destroy the relationship?

What are the odds they would default. According to the FTC, depending on the type of the loan, as many as three out of four primary borrowers default on their obligations, leaving the cosigner to pay. This is, after all, why they need a cosigner: they're not good credit risks, either because they have too much debt already, or because they don't pay their bills on time.

This is their first real excursion into the world of credit for almost 10 years. They are learning first hand the result of messing up your credit. Sure the downside of bad credit is having the worst possible interest rates when borrowing money. But this is a great lesson and it will leave a bad taste in the mouth for many years to come. It's something they will never forget and hopefully never repeat. My intervention may circumvent this life lesson and postpone learning a hard truth.

You're not really helping someone if you assist them to take on a large car loan when they have had historical trouble paying their bills, or to refinance their debt without attacking the spending that brought on the debt in the first place. "Helping" people to avoid dealing with their problems isn't much help at all. It feels terrible to say no, and the person will probably be hurt when you do. It may sour the relationship. But keep in mind that however bad it feels, and however much the relationship suffers, this is nothing compared to the bad feelings and relationship problems that you will encounter if you become their chief creditor.

3 comments:

  1. Deciding on cosigning a loan is an interesting topic. If done at all you need to consider not only the credit risk of the borrower but also the value of the asset being financed and the debt burden that might potentially become yours.

    For example I would never cosign a home mortgage for anyone, I don't want the risk of that large a payment becoming mine. I've been asked to cosign a student loan before. I declined because of the credit risk of the other borrower but also because the education financed is worthless if a degree is not obtained. A large percentage of college students never finish their education and I won't put myself at risk for paying an uncollateralized debt.

    The one type of debt I might consider cosigning would be a car loan. The payments are low relative to my income so they would be manageable. The car has value if the first borrower can't pay, I could assume ownership of the car or sell it and take a smaller loss on paying off the debt. In addition I can more easily tell if the original car purchase is a wise financial decision. Are they buying a used base model two door or a high end fully loaded gas guzzler?

    I do agree that it can be more harmful to help someone out of a tough financial spot than it is to let them wallow through it. Perhaps your decision might have been different if they could not finance a car at all?

    One other risk I noticed that you didn't highlight was that your daughter and her boyfriend were buying the car together. I would never cosign a loan backed with two people who were dating. Forget the financial risks that they don't pay. If they decide to split up you are in for a really unpleasant situation.

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  2. I would finance a car loan for my daughter if I had the money to buy the car outright if something happened. If I was deeply in debt, I would not.
    We bought our daughter a car- and put it ONLY in her name. After they were married two years my daughter put her husband on the title.
    Don't do it if you can't afford it.
    Personally, I would rather my child be in a car I can rely on than something I would be wondering about at 2 am when she got off a late shift at work.

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  3. Bill, the car is actually in the boyfriends name. I am glad you brought that up, it didn't occur to me. I am not going to do it though my main reason is I don't have the money to. Second, I worry that they are well motivated to continue paying when it's their name on the loan instead of mine. Third, I think a lot of lessons are being learned in the process. Thanks for the comment.

    JBO, my daughter and boyfriend both are working and are able to pay the loan. But their credit is very bad from past problems. I am not financially able to pay it if a problem came up. I worry about the relationship that could occur if things went south. Thanks for the comment.

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