When you need to seek financing to get a used or new car, the lender looks at different aspects of your finances to determine if you make enough money and have good enough credit to justify giving you the car loan. Whether you've never used credit before or just fall short of meeting the lender's standards, you might consider getting a loved one or someone you know to act as a co-signer and share the responsibility of the loan with you.
While this could be just what you need to get approved, it's important to consider how this decision can impact your finances and your relationship. Take a look at what's needed to get a car loan approved with your own credit and what you should know about having someone co-sign.
Understanding Car Loans
A car loan can make it easier to afford a car since you'll make monthly payments that get spread across several years rather than paying the whole price upfront. As with other types of credit, lenders charge you an interest rate based on factors like your loan term and credit score. Further, they use various financial criteria to determine the loan amount for which you qualify.
The catch is that this is a secured loan where the lender has a claim on the vehicle – and usually even their name on the title – until you've fulfilled your obligation to pay back the whole loan. This means that the car can get repossessed if you fail to pay for it for an extended time, and you can expect late fees as you would with missed payments for any type of loan or credit line. After you've made the last payment, the car belongs to you, and the title can be changed to show only your name.
Exploring Credit Requirements
One of the main criteria that auto lenders look at when you apply for a car loan is your credit standing. Your credit history and score determine whether you can get approved, and they also have an impact on the interest rate you pay and the type of borrowing options you have.
Generally, having a good credit score of 670 or higher boosts your likelihood of getting approved through lenders like banks, credit unions and in-house financing programs at car dealerships. Scores in this range usually also yield lower interest rates and can help you get approved for special offers like 0 percent financing through manufacturer's programs.
However, having a score below this range doesn't automatically mean no lender will give you a car loan. Rather, you can expect to pay a higher interest rate if approved, and you may need to consider options like bad credit lenders or a co-signer to move forward with getting your car.
Along with your credit score, your credit history in general can encourage or discourage lenders from giving you a car loan. Having a bankruptcy within the last decade can particularly become a roadblock since it hurts your credit score and shows up as a negative public record on the credit report. Waiting as long as possible after the bankruptcy can help. You can also have someone else help you get the loan or seek a lender who's willing to work with you despite the bankruptcy.
Read More: What Is a Prime Credit Score for an Auto Loan?
Considering Income Requirements
Even if you have great credit, an auto lender likely won't give you a car loan unless you can show that you have a reliable source of income that allows you to handle the monthly payments. Depending on the lender, they might set a minimum income amount such as $2,000 a month, especially if you have bad credit, and you'll need to show that the income has been stable and established for some time already. Also, you can expect the lender to look at your current income sources and monthly debt payments to calculate what you can afford to pay for a car loan each month.
There are a few different ratios the lender might consider in the decision for your maximum car loan amount. One of these is called the payment-to-income ratio and involves dividing your possible car payment by your monthly income. The lender usually wants to see that your car loan payment doesn't exceed around 20 percent of what you make.
The other is the debt-to-income (DTI) ratio that considers all other debt payments like your credit cards, student loans and mortgage alongside your monthly income. The maximum acceptable DTI ratio usually doesn't exceed 50 percent.
There are some actions you can take if you're concerned about having enough income or too much debt to meet lender requirements. Making a down payment and selling or trading in your old vehicle can reduce the amount of the car loan you need and lead to lower ratios. You can also take time to work on paying off some of your other debts or even shopping around for a cheaper vehicle, like a used car, to overcome some of these hurdles.
Looking Into Co-Signing
If you take a look at the common requirements for getting a car loan, you may worry you'll have trouble with approval due to bad credit, a high load of other debt like student loans or an income that is too little or too unstable. In such situations, you can look for a person to act as the loan's co-signer so you can benefit from their credit history and income information to get an auto loan when you couldn't get one alone. Usually, your co-signer is a close friend or family member, such as a parent or partner. However, any willing person who meets the standards for an auto loan could agree to be your co-signer.
When you use this option, you're the primary borrower for the auto loan, but the co-signer is also legally obligated for the loan and it appears on their credit report, too. This means the lender expects your co-signer to make your car payments if you can't for some reason, and all the actions related to the debt impacts the credit report of both parties. The obligation of the co-signer remains until you've fully paid off your car loan or until you pursue a refinance to get a new car loan just with your name on it.
To use the co-signer, you need to find out which requirements the lender has for them. Usually, this means a credit score at least in the upper 600s as well as enough income to take over your car payment if you're unable to pay it. The co-signer's debt-to-income ratio can't be too high, which usually means not exceeding 50 percent. If the person already has a mortgage and several other debts, then they might not be able to take on this role for you, even though you'd be the one actually making the payments.
Read More: What Do I Need to Not Have a Cosigner on a Car Loan?
Benefits of Using a Co-Signer
Whether your credit score is too low for a good interest rate or you can't show a stable income to the lender, using a co-signer can offer numerous benefits.
As long as you choose a co-signer who has a very good credit record, you can boost your chances of approval because the lender considers the co-signer's financial information and income. This can help you qualify for an auto loan amount that's higher than you could get with your income information alone. It could also lead to a lower interest rate so you don't end up paying too much for the car over time. In some situations, using a co-signer can help avoid a down payment or decrease the amount needed up front.
Having someone act as a co-signer for your auto loan can also help your credit in general, especially if you've never borrowed anything before or you're working on improving your credit after issues like missed payments or bankruptcy. As you make your auto loan payments on time, you can improve the payment history component of your credit score. Since the auto loan appears on both credit reports involved, your co-signer can benefit as well, as long as you handle the loan responsibly. So it can be a win-win decision when done right.
Downsides of Using a Co-Signer
While having someone serve as your auto loan's co-signer can help you out, it also puts a lot of weight on your co-signer since your actions can hurt them financially and put a strain on the relationship you have with them. Missed payments damage not only your credit score but also the co-signer's. This means that both of you can have trouble getting credit in the future, and if you do, higher interest rates may be involved to compensate for the added risk.
The co-signer also has the disadvantage that your car loan shows up as their debt, so when they go to apply for another loan, the lender adds that amount in their debt-to-income ratio, even though the co-signer doesn't have the car in their possession.
These financial risks mean that you have to consider your co-signer's interests at all times. If you have financial troubles and can't make your payment on time or end up having the car repossessed due to nonpayment, the relationship with them can get tense as they could get stuck paying for your car loan to avoid credit damage.
In the most extreme cases, your actions can even result in a lawsuit or lien for the co-signer. So it's recommended to only proceed with a co-signer if you can handle any relationship issues and have a high level of certainty that you can pay off the debt as scheduled.
Applying With a Co-Signer
If you and your co-signer have agreed to apply for the car loan, here are the steps you can expect to take:
- Gather needed documents and information: You and the co-signer should check your credit reports and scores, obtain documents supporting your income and total your monthly debts so that you can assess loan affordability and have the documentation the lender requires for processing the application. You also need photo IDs, documents verifying residency and proof that you'll have insurance for the financed vehicle.
- Seek potential lenders: You could just use the in-house financing at the car dealership, but it's worth looking around at credit unions and banks in your area since you could get better rates. Most of these lenders allow creditworthy co-signers, so that's usually not an issue. Instead, focus on the loan terms they offer as well as factors like customer service and the willingness to work with people in a variety of credit situations, if necessary.
- Look into pre-approval: With the financial information gathered from earlier and an estimated car price in mind, choose a few potential lenders and look into getting pre-approved online or in person. Expect to provide details like income and debts for both of you. You'll also undergo soft credit checks to estimate an interest rate and loan amount. You're not obligated to take any specific offer, so you can compare them based on factors like the maximum loan offered and the interest rate.
- Complete the application: When you've chosen a car and are ready to proceed with your co-signer to finalize the financing, you finish the car loan application process by filling out forms online or in person with personal information for you and the co-signer. You also present the necessary documents and identification the lender requires. Both of you sign the car loan application and learn of the final approval.
Read More: How to Get a Car Loan
Once you've obtained the auto loan, pay it according to its terms to avoid credit issues and problems with the co-signer. Also, stay in communication if you do run into financial trouble so that you can work something out and minimize damage to your credit profiles and your personal relationship.
- Credit.com: The Ultimate Cheat Sheet for Cosigning a Loan
- Equifax: The Pros and Cons of Cosigning Loans
- Auto Credit Express: How Does a Cosigner on a Car Loan Work?
- Experian: What Credit Score Does a Cosigner Need?
- Experian: How to Qualify for a Car Loan
- Credit Karma: Can I Get a Car Loan After Bankruptcy?
- The Car Connection: Do You Have Enough Income for a Car Loan?
- Bank of America: How Car Loans Work
- Credit Karma: Applying for an Auto Loan: What You Need To Know
- US Bank: Apply for Pre-Approval for an Auto Loan
- Consumer Financial Protection Bureau. "What Is a Co-Signer?" Accessed Dec. 18, 2019.
- Santander Bank. "Personal Loans From Santander Bank." Accessed Dec. 18, 2019.
- Wells Fargo. "Personal Loans." Accessed Dec. 18, 2019.
- Consumer Financial Protection Bureau. "What Are Common Credit Report Errors That I Should Look for on My Credit Report?" Accessed Dec. 18, 2019.
- Consumer Financial Protection Bureau. "How Do I Get and Keep a Good Credit Score?" Accessed Dec. 18, 2019.
- New York State Higher Education Services Corporation. "NYHELPs Cosigner Liability and Release." Accessed Dec. 18, 2019.
Ashley Donohoe has written about business and technology topics since 2010. Having a Master of Business Administration degree, bookkeeping certification and experience running a small business and doing tax returns, she is knowledgeable about the tax issues individuals and businesses face. Other places featuring her business writing include Zacks, JobHero, LoveToKnow, Bizfluent, Chron and Study.com.