If you have good credit, you may be asked by a family member or a close friend to co-sign with them for a car lease or loan. You’d like to help them out but aren't sure if you should do it.
What does it mean when you co-sign a lease? What are your responsibilities? What risks are you assuming?
Let's look at the pros and cons of co-signing a car lease.
What Does Co-Signing Mean?
Co-signing a car lease is a way for someone with bad credit or not enough credit history to get approved for a lease by using the credit of someone who has a strong credit score.
Co-signing doesn't mean you're simply giving a character reference for the borrower. When you co-sign a lease, you're putting your name on the lease and assuming full financial responsibility. However, co-signing a lease does not give you any ownership in the vehicle or the rights to use it. In fact, co-signing a lease has very little benefit for the co-signer.
A co-signer has the same obligations as the principal driver to maintain the car and make any necessary repairs. If the car is in poor condition at the end of the lease, the leasing company may impose charges to make repairs. If the primary driver and yourself fail to pay these charges, this will affect your credit score. The same penalties would apply for over-mileage-limit charges.
Once you sign the lease, you can't change your mind and back out. You're liable until the lease has expired or until the primary signer has been able to get another lease without requiring a co-signer.
Read More: Advantages & Disadvantages of a Co-signer
What Is the Risk to Your Credit?
The lease obligation will appear on your credit report, and any late payments appear on both the primary borrower's credit history and yours. Late payments have an immediate negative effect on your credit score and stay on your report for seven years.
Co-signing a lease may also affect your ability to get a loan in the future. Leases are reported to the credit bureaus like installment loans. Lenders look at the remaining balance owed and add it to your other debt to calculate your debt-to-income ratio. You could get into a situation where your application for a loan could be declined because your debt-to-income ratio was too high.
If you're thinking about applying for a home mortgage or maybe even a car loan for yourself, you could be denied because your debt-to-income ratio is too high as a result of co-signing for someone else's car lease. In this case, you’d have to wait until the lease is paid out and your debt-to-income ratio goes back down for you to qualify for the auto loan you want for yourself.
What Financial Risk Do You Have as a Co-Signer?
If the original obligor makes late payments on the lease, you may have to step in and make the payments yourself to protect your credit rating. So you need to ask yourself if you can afford to step in and make up late payments if it becomes necessary.
What happens if the worst case scenario happens and the primary signer defaults on the lease? Can you afford to make those monthly payments until the lease is completely paid off?
When you co-sign for a lease, you have to be prepared financially to deal with late payments and defaults entirely by yourself with no help from your friend. If the original borrower does not make the payments, the lender could initiate a lawsuit against you personally and maybe even garnish your wages if you don’t bring the account current.
The lender may not notify the co-signer immediately about late payments. It's a responsibility of the co-signer to monitor the monthly lease payments and make sure they're paid on time. It is only after the original obligor stops making payments that the lender will get in touch with you.
Read More: Can Anyone Get a Loan If They Have a Cosigner?
How to Manage If You Do Co-Sign
Make arrangements with the lender to have access to monthly status reports or to get monthly statements. If this is not possible, are you willing to ask your friend or family member each month if they have made the payment? How will this affect your relationship? Will it appear that you're being overbearing and intrusive?
The most valuable objective for a co-signer is to make a plan with the borrower to overcome the obstacles and create a path to a solid credit history that enables the borrower to get credit on their own. The failure to develop a way for improvement may risk ruining the relationship.
What Are the Benefits of Co-Signing a Lease?
Co-signing a lease for a family member or friend with bad credit can enable them to get a car and get on a path to establishing a strong credit history. If you're a co-signer with a prime credit score, it allows your friend to get a car lease with a decent, affordable rate and less restrictions, rather than a higher cost that's difficult to overcome.
If the primary signer makes all the payments on time, both parties could see their credit scores go up. In this case, you could help a friend or family member and get a higher credit score for yourself, too.
Read More: Do Cosigners Need Good Credit or Income?
What Are the Alternatives to Co-Signing?
While it would be expensive because of higher interest rates, sometimes it's better for your friend to build credit by taking out a loan designed for those with bad credit instead of using a co-signer. It may be financially difficult at first, but starting out with on-time loan payments will provide a foundation for them to build a good credit score.
Another way to help someone build up their credit is to make them an authorized user on your credit card. You don't have to let them use your credit card, but they will benefit over time from your good credit history without you taking any risk as a co-signer.
Co-signing a lease makes you totally responsible for the entire amount. In the event of default, you have to be prepared financially to take over the payments and pay off the balance of the lease.
Co-signing not only puts you at financial risk, but it can affect your credit score. It may also strain your relationship with your family member or friend. Becoming a co-signer has a number of pitfalls, and you should have a compelling reason before you commit to assuming these risks.
- Credit Karma: Co-Signing for a Car: Should You Do It?
- Experian: If I Use a Co-Signer to Lease a Car, Will the Account Show on Their Credit Report or Mine?
- Progressive: What to Know Before Cosigning a Lease
- U.S. News & World Report: What You Need to Know About Co-Signing a Car Loan
- The Nest: Does a Vehicle Lease Show on Your Credit Report?
- FICO. "Average U.S. FICO Score Hits New High." Accessed Sept. 21, 2020.
- Consumer Financial Protection Bureau. "Borrower Risk Profiles." Accessed Sept. 21, 2020.
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.